Barclays warned in a note on Friday that European equity markets could deliver a sharp relief rally if the Iran conflict is brought to a quick close, while the alternative - a protracted closure of the Strait of Hormuz - would heighten downside risks for the region's stocks.
The bank framed the trade between European and U.S. equities as becoming more of a direct "call on oil direction." Analyst Emmanuel Cau observed that European shares have traded in a narrow band for over a month as market participants oscillate between optimism and pessimism tied to peace negotiations.
Sentiment received some support recently from renewed talk about a potential U.S.-Iran agreement, Cau noted, but he cautioned that headlines remain volatile and can shift rapidly.
Barclays highlighted a weakening macroeconomic backdrop in Europe. The latest European purchasing managers' indices dropped to their weakest levels in two and a half years, missing expectations and signaling a clear loss of momentum. While first-quarter earnings in Europe have been robust, the bank said the deteriorating macro indicators make it difficult to justify additional earnings upgrades at this stage.
The note also contrasted regional strengths, saying the United States continues to benefit from energy independence and exposure to an AI supercycle, factors that are widening the performance gap with Europe under current conditions.
Barclays pointed to the risk that persistently high energy prices could lead to demand destruction. The bank further warned that, without a swift resolution to the conflict, concerns about a potential European Central Bank policy mistake may begin to weigh on the euro versus the dollar.
Conversely, if peace materializes quickly, Barclays suggested markets could look past near-term softness in data, opening the door to a notable relief rally in European equities - a rebound Barclays expects would likely be led by cyclical sectors and banks.
Implications for investors
The firm’s analysis implies that near-term market direction for Europe will be heavily influenced by developments in energy markets and geopolitical outcomes related to Iran, with cyclical sectors and financials positioned to benefit most from a rapid de-escalation.