European stock markets have experienced an unusual August rally, with the EURO STOXX 50 reaching an all-time high above 6,560 points, up approximately 13% since the start of the year. Germany's DAX also surpassed 26,450 points, and France's CAC 40 closed around 8,740 points, both near record levels. This performance defies historical data that typically shows August as a month of modest average losses for European equities, often attributed to thinner summer trading volumes making markets more susceptible to shocks. Analysts point to strong corporate earnings, particularly in technology and energy, and easing geopolitical tensions, including cooling hostilities in the Middle East and lower oil prices, as key drivers for this strength. Approximately three-quarters of the STOXX 600 companies are trading above their 200-day moving average, indicating a broad-based rally. Corporate dealmaking, such as speculation around a multi-billion-euro software industry transaction involving SAP, has also contributed to the upward trend.
Despite the record highs, strategists remain cautious. Historically, August's poor reputation stems not from consistent underperformance but from a few severe, unpredictable shocks that have led to significant losses. The current period of thin summer liquidity, coupled with record high valuations, suggests that markets might be more exposed to an unexpected shock than they appear. JPMorgan Private Bank's Madison Faller advised investors to be more selective with European stocks, noting that improving earnings are increasingly reflected in current valuations.
Adding to the complexities, European government budget season, beginning in September, is expected to be challenging. Inflation, driven by the Iran oil shock, and the European Central Bank's rate hikes are creating a more volatile autumn. Political uncertainties in major eurozone economies, particularly France, further complicate budget-setting. French 10-year OAT yields have reached an 18-year high, and the borrowing premium over Germany is back to levels seen during the last budget crisis two years ago, leading to a decline in French bank stocks. Fitch is also expected to review France's credit rating, adding to fiscal and political concerns ahead of next year's presidential election.
