Markets have dropped fast - and hard. The FTSE 100 is down more than 10% in the past week, the S&P 500 has fallen 9.6%, and Germany’s DAX and France’s CAC are each off by more than 11%. But, according to Panmure Liberum, the reaction may have gone too far.
The firm argues that while the introduction of new tariffs by the United States has triggered a sharp repricing, the market is now assuming a level of long-term damage that is historically extreme.
Using a dividend discount model, Panmure estimates that the current fall in the S&P 500 implies seven years of zero corporate earnings. For the FTSE 100 and FTSE 250, it suggests three to four years without growth. UK small caps are priced as if earnings will not grow for five to six years.
Zero gain?
“We never had such a long period of zero earnings across the market in modern history,” the firm writes.
The UK government has ruled out retaliatory tariffs. Panmure points out that the underlying growth outlook for Europe and the UK has not changed.
Long-term drivers such as higher public infrastructure and defence spending remain in place. Germany is set to spend €500 billion over the next decade, while the UK has reaffirmed its commitment to defence spending equivalent to 3% of gross domestic product by 2030.
Bond markets, too, are sending signals that do not align with Panmure’s view. Five-year breakeven inflation expectations have dropped by 20 basis points in the US and UK, which the firm says suggests markets are expecting a one percentage point disinflationary effect from the tariffs.
In contrast, Panmure’s model anticipates a one percentage point inflationary impact in the US alone, with little inflation pressure in Europe unless retaliatory tariffs are introduced.
Forex markets in confusion
Currency markets are also behaving unusually. The US dollar weakened against most major currencies in the days following the announcement, despite rising inflationary pressure.
Sterling held steady. Panmure interprets the move as a possible early sign that confidence in the dollar’s role as a safe haven may be eroding.
Valuations have shifted sharply. The firm says the UK’s cyclically-adjusted price-to-earnings ratio is now 13.6 times, around 20% below the long-term average. For Europe, it is 14.5 times. In contrast, the S&P 500 is still above its long-term norm at 33.4 times.
Forward valuations paint a similar picture. UK large-, mid- and small-cap indices are all now priced in the lowest decile since records began in 1996.
Equities will still deliver returns
Based on Panmure’s analysis, these valuation levels have historically been followed by annual nominal returns of close to 10%. In the case of UK small caps, that figure rises to as much as 15% over the next three to five years.
Panmure draws a parallel with the aftermath of the dot-com crash. Between 1999 and 2003, US valuations fell and capital began to shift toward UK and European equities.
The firm suggests current conditions may lead to a similar reallocation, particularly as the valuation gap between the US and UK widens further.
Despite recent volatility, Panmure says its long-term earnings forecasts are unchanged.
Earnings on track
It expects annual earnings growth of 7.% in the UK and 7% in Europe, compared with 5.9% in the US. These estimates are based on assumptions including real GDP growth, inflation, infrastructure investment, and margins.
Its ten-year total return forecasts now stand at 16.6% for UK equities, 11.7% for Europe, and 7.6% for the US.
Panmure’s conclusion is that while the short-term outlook is uncertain, valuations now imply a level of pessimism that is historically rare. The longer-term case for UK and European equities, it says, remains intact.