Riding on the back of renewed optimism over the inflation outlook and monetary policy path, European equities continued the rally in November, despite no material shift in the macroeconomic backdrop. Over the month, the Euro appreciated 5.30% over the Dollar, and the European STOXX 600 index gained a further 6.75% (11.38% in US$ terms).

PMIs slightly improved over the previous month, although they remain in the contraction zone. The headline CPI has also recorded MoM fall, which could be a sign that inflation has finally peaked, but the figure itself is still very elevated. Overall, we don’t see a material shift in the economy itself, as key risk factors remain in place. Moreover, the ECB will likely continue its ongoing monetary tightening plans, higher interest rates hit both the physical economy and valuation levels, putting more downward pressure on the equity market.

Other than the climbing rates, there are still a few sources of risks that market have not sufficiently priced in. Recession is one, given the significant slowdown in the economy, the ECB minutes have acknowledged that recession is a definite possibility from Q4 2022 onwards throughout 1H 2023. Provided that corporate earnings have yet to be downward revised, equities could fall further. Furthermore, quantitative tightening will likely rollout somewhere down the road, reducing liquidity from the market further pressures equity valuations. Given unchanged headwinds, current valuations are unattractive, downside risks outweigh upside potential, and we maintain our underweight call on European equities in the meantime.