European equities could correct 10% over summer - Morgan Stanley

(Reuters) - European equities could fall by 10% over the summer as slowing economic growth and deteriorating liquidity dampens earnings, Morgan Stanley said on Monday.

The brokerage cut its sector rating on financials to "neutral," while upgrading pharmaceuticals one notch to "overweight," amid a shift in preference to defensive stocks over cyclicals.

Morgan Stanley said that European companies have held up better than those from the rest of the world in 2023 and narrowed the estimated fall in profit this year to 6% from 10% earlier.

"We still anticipate a downgrade cycle commencing in H2 2023 due to lower margins and weaker economic growth (which we think is just beginning)," lead equity analyst Graham Secker said.

However, this downgrade cycle is starting later than expected, which limits a potential rebound in 2024, Secker added.

The pan-European STOXX 600 index has been resilient, with a more than 8.8% increase this year after losing nearly 13% in 2022.

The index has come under pressure recently after the European Central Bank remained steadfast in its commitment to taming price pressures, lagging behind the S&P 500 index that is up nearly 12% year-to-date.

Secker said that financials have been driving Europe's "superior" earnings performance this year but flagged limited scope for further growth.

Since it has been more than a year into the Fed's aggressive hiking cycle, the headwinds to profit from the monetary policy are likely coming closer, the brokerage said, noting that historically, tighter credit conditions manifested over the longer term.

(Reporting by Aniruddha Ghosh in Bengaluru; Editing by Savio D'Souza and Dhanya Ann Thoppil)