Market strategists are expressing optimism about European equities, anticipating a return to record highs despite concerns over inflation fueled by the Iran conflict. According to a survey, the median forecast from 16 analysts projects that the STOXX Europe 600 Index will rise approximately 11% from last Friday's close to reach 635 points by year-end. Strategists currently view the conflict and surging oil prices as temporary factors that will not hinder an acceleration in European economic growth.

This month, none of the surveyed analysts lowered their target prices for the European benchmark index, with Unicredit SA and Deka Bank even slightly increasing their projections. Deka Bank, alongside HSBC Holdings, ranks among the most bullish institutions, setting a target of 670 points, implying a potential 17% gain. Conversely, the two most pessimistic strategists—TFS Derivatives and Bank of America—see a downside risk of about 2% for the index.

The survey was conducted prior to the U.S. President's ultimatum demanding Iran fully reopen the Strait of Hormuz within 48 hours. The Middle East conflict has disrupted global energy markets, raising concerns that central banks may need to raise interest rates to combat soaring price pressures amidst economic weakness. However, the most optimistic strategists are looking beyond these risks, hoping for a swift resolution to the war to restore the positive growth and earnings expectations seen at the start of the year.

A team led by Mislav Matejka at JPMorgan stated, "While a sharp escalation in the Middle East naturally triggers risk-off behavior in the short term, looking beyond the next few days/weeks—over a 3, 6, or 12-month horizon—we believe market weakness should be used to add exposure." They added, "Military conflicts are inherently unpredictable, but given the political calendar, we believe a prolonged escalation is unlikely, and we find the fundamental backdrop to be positive."

According to the latest fund manager survey from Bank of America, optimism toward European equities has "weakened but not disappeared." Concerns have shifted from being overly underweight stocks to potentially not being underweight enough. The percentage of respondents seeing market upside in the coming months dropped sharply to 36% from 67% a month ago, while those expecting gains over the next year fell from 89% to 71%.

Behind the overall forecasts, market sentiment has undergone a significant shift, at least in the near term. Worries over inflation and economic risks have dampened investor enthusiasm for European fiscal stimulus and robust earnings growth expectations. Since the outbreak of the war, Brent crude prices have surged over 50%, and natural gas futures have nearly doubled. The STOXX 600 Index has fallen 11% so far in March, on track for its worst monthly performance in six years. Whereas markets initially anticipated ECB rate cuts at the start of the year, traders now fully expect three rate hikes by 2026.

Laurent Douillet, Senior Equity Strategist at Bloomberg, commented, "The Iran conflict has reset a key threshold for European equities: during past oil price spikes, median returns for most sectors were positive until Brent surpassed $100 per barrel. Beyond that level, the pool of leading sectors narrows and economic risks rise. The German DAX Index is most affected due to its negative oil beta and energy-intensive bias, while the UK's FTSE 100 and France's CAC benefit from higher weightings in the energy sector."

Although investors have been reluctant to aggressively sell off stocks during the conflict, they have begun rotating exposure into more defensive sectors like telecommunications and utilities. They are taking profits from recent top performers and cyclically sensitive stocks—such as banks, mining, autos, and construction materials. While rising oil prices have buoyed energy stocks, airlines have suffered significant losses.

Beata Manthey, Global and European Equity Strategist at Citigroup, said, "We downgraded European continental equities from overweight to neutral in January due to rising geopolitical risks and increased headwinds for exporters." She maintains a 640-point target for the STOXX 600. "Although sensitivity to energy prices is lower than in 2022, persistently high energy costs could still pressure Europe's energy-intensive manufacturing sector. However, it is reassuring that previously optimistic investor positioning has now fully unwound, both at the broader index level and within European banking."

Citigroup strategists are overweight on UK stocks, which have historically served as one of the most effective hedges against geopolitical turmoil. Since the Iran conflict began, the FTSE 100 has declined 8%, while the eurozone benchmark index is down 10% in U.S. dollar terms. Meanwhile, even after recent declines, European stocks are less attractive than before, trading at a price-to-earnings ratio near 15 times forward earnings, above the 20-year average of 13.3 times.

A team of strategists led by Sharon Bell at Goldman Sachs wrote, "European equity valuations remain attractive compared to the U.S., but they are no longer cheap, and the valuation cushion would shrink if geopolitical risks persist or intensify. We continue to forecast EPS growth rates of 5% and 7% for 2026 and 2027, respectively, well below bottom-up consensus estimates of 11%/12%, but still positive under our assumptions."