Morgan Stanley said it is maintaining a cautious stance on European equities, warning that rising geopolitical tensions and the resulting boost to energy costs are increasing risks to both corporate earnings and market valuations.
Strategists including Marina Zavolock noted that they now see a "rising risk of our bear case" for the MSCI Europe index, which implies roughly 17% downside based on historical precedents.
Earnings pressure centers on ex-energy profits
The team emphasised that the more acute challenge is not necessarily headline earnings - which can be supported by a stronger energy sector and currency moves - but the deterioration in earnings excluding energy and the contraction of valuation multiples. They pointed to the 2022 energy shock as an instructive episode: while headline numbers appeared resilient, MSCI Europe earnings excluding energy fell about 7% from peak to trough.
Morgan Stanley’s analysis indicates that a sustained climb in oil would inflict a more substantial drag on underlying profits. In a scenario where Brent averages $140 per barrel in 2026, the strategists estimate roughly an 8% decline in European earnings excluding energy, versus current expectations of 11.8% growth. They warned that increases in Brent above $120 per barrel could produce non-linear downside for both headline and ex-energy earnings.
Valuations vulnerable to compression
The group also flagged valuation risk. Current MSCI Europe forward multiples sit near 15x, a level comparable to readings seen before prior geopolitical shocks. The strategists observed that those earlier episodes saw meaningful multiple compression - to 10.6x during the 2022 Russia-Ukraine crisis and as low as 7.5x during the 1970s oil embargo.
Sectoral winners and losers likely to diverge
Morgan Stanley expects sector performance to be uneven if energy-driven stress persists. Historically, Energy, Telecoms and Utilities have shown relative resilience during such shocks, alongside defensive areas such as defence, tobacco and food retail. Conversely, Autos, Semiconductors and consumer durables have typically been among the hardest hit. The strategists also flagged additional downside risks for banks, capital goods and travel-related sectors.
Credit market strains add to concerns
On the credit side, the bank’s strategists said conditions are beginning to deteriorate, citing early signs of fund outflows and weakening returns. They described the current risk-reward profile in credit as poor and warned that further increases in commodity prices could widen spreads and trigger additional selling pressure.
This assessment underscores Morgan Stanley’s cautious posture: rising energy costs and geopolitical uncertainty are seen as heightening the chance of a downside outcome for European equities, with earnings excluding energy and valuation multiples the primary channels of risk.