Morgan Stanley: European stock markets face "ongoing tactical risks"

Investing.com — Amid escalating geopolitical tensions, European stock markets face ongoing tactical risks. Morgan Stanley reaffirms its preference for defensive stocks over cyclical stocks, as oil price sensitivity continues to reshape market rotation patterns.

In a report released on Tuesday, the firm noted that since 1990, geopolitical risks have significantly increased five times, using the Geopolitical Risk (GPR) index as a mapping framework.

Get real-time market headlines and analyst alerts on InvestingPro — Enjoy a 55% discount

Among these events, three—Gulf War, Iraq War, and Russia’s full invasion of Ukraine—had uncertainties lasting over 14 weeks, with European stocks averaging a 24% pullback within about 26 weeks.

During these longer periods, cyclical stocks underperformed defensive stocks by an average of about 17%, while oil prices rose by 38%.

The other two events—September 11, 2001, and the 12-day Iran-Israel conflict in 2025—were short-term escalations lasting less than three weeks, with market declines from peak to trough of 15% and 3%, respectively.

Since mid-February, cyclical stocks have underperformed defensive stocks by 6 percentage points. Morgan Stanley shifted its sector preference toward defensive stocks earlier that month, initially driven by AI disruption risks. The firm states that the current geopolitical environment further reinforces this stance.

On March 2, only energy, defense, and technology hardware sectors closed positively. Most underperforming sectors were cyclical. Aerospace, automotive, banking, and luxury sectors showed the strongest negative correlation with oil prices, while energy, metals and mining, and defense sectors exhibited the strongest positive correlation. This is based on Morgan Stanley’s reference to March 2022, when correlations between stocks and oil prices shifted significantly after Russia’s invasion of Ukraine.

The stock groups most positively correlated with oil prices have outperformed the least correlated groups by 12% since mid-December. Morgan Stanley describes this trend as “significant change, but below 2022 levels.”

Among the top 50 MSCI Europe stocks most positively correlated with oil prices, Shell, Galp Energia, and Equinor rank highest, with three-month daily correlations of 72, 69, and 68, respectively, as of March 2022 data.

At the bottom of the correlation spectrum, Amundi, Renault, and Skandinaviska Enskilda Banken show the highest negative correlations, at 58, 50, and 47.

European natural gas prices also surged sharply, with TTF prices spiking in early 2026. According to Morgan Stanley research, sector sensitivities to TTF natural gas prices are roughly similar to oil prices, with energy and defense sectors leading in positive correlation, while banking and automotive sectors are at the negative end.

The Iraq War in 2003 and Russia’s invasion in 2022 are the clearest examples of prolonged uncertainty. European stocks sold off in anticipation of the Iraq War, bottoming out before the conflict began, while after Russia’s invasion, markets experienced a sharp but ultimately short-lived recovery.

Morgan Stanley states, “When uncertainty persists, recovery phases tend to be delayed,” and in cases of long-term uncertainty, “cyclical stocks have further downside potential.”