Leading analysts, including BlackRock Inc. and Amundi SA hedge funds, warn that markets are overoptimistic about future risks. The ongoing rally in stock markets could overshadow the investment outlook. More agencies have already downgraded ratings of corporate earnings. Besides, the ECB sticks to its hawkish rhetoric in the face of a recession because inflation remains at elevated rates, albeit a minor slowdown. The war in Ukraine which was unleashed almost a year ago is unlikely to end soon.

"It's dangerous to think just because stocks are going up that things are okay," said Kasper Elmgreen, head of equities at Amundi. "We've now got a very high conviction that 2022's resilience will break. The market has not yet appreciated the magnitude of earnings downgrades ahead."

A decline in energy prices, the signs of easing inflationary pressure, and a robust recovery in China improved sentiment in global stock markets. Euro Stoxx 50 gained 27% from the low printed in September 2022. On top of that, investment capital is again flowing to European hedge funds after a yearlong capital flight.

Nevertheless, reputable portfolio managers are still cautious. CME reports show that growth in stock market quotes has been propelled by the fact that sellers were fixing short positions. Strategists at BlackRock Investment Institute say that optimism on Wall Street emerged prematurely. Goldman Sachs Group Inc. and Bank of America Corp. warned that the best part of the 2023 rally might be left behind.

Risks of military escalation

Russia's control over gas supplies to Europe still poses a threat to economic growth. The milder-than-anticipated winter helped the region to escape from the energy crisis. Nevertheless, political interference might be required unless Russia terminates its gas supplies in full.

The Kremlin's original rhetoric was to invade Ukraine in a few weeks. It goes without saying that Moscow has failed in its ambitious goals. Meanwhile, Vladimir Putin is orchestrating a new broader advance to Ukraine. At the same time, Germany and the US are delivering tanks to Ukraine, making joint efforts to equip the country with sophisticated and high-powered munitions. Such moves signal the escalation of the conflict is around the corner.

The energy war could last indefinitely, Wisdomtree UK Ltd associate director Aneeka Gupta predicts. Since the EU cannot always rely on favorable weather, measures such as replenishment of gas reserves and rationing energy demand should be given priority, the analyst stated.

Risks of corporate forecasts

Analysts are cutting earnings forecasts at the start of the reporting season, with some strategists calling for more cuts amid a slowdown in economic growth. As inflation has been falling, it is also becoming increasingly difficult for companies to raise prices at a time when demand is waning.

Soaring inflation in tandem with higher rates will hurt the liquidity of many companies as margins shrink and servicing their debt becomes more expensive.

The first results of the reporting season show that there is cause for concern in various sectors. Retailer Hennes & Mauritz AB said rising costs nearly wiped out profits in the last quarter. Wind turbine maker Vestas Wind Systems A/S warned of another hit to sales this year. Software developer SAP SE plans to cut jobs in an attempt to increase profit.

Analysts are forecasting strong revenue growth in Europe this year. Top-down market strategists share the bleak outlook. Goldman Sachs, UBS Group AG, and Bank of America expect corporate profits to fall 5% to 10%, pointing to further stock losses as valuations catch up with lower forecasts.

Risks of aggressive monetary tightening

Recent messages from ECB policymakers suggest that the regulator will stick to the hawkish stance, i.e. it will go ahead with raising interest rates until they see a more significant reduction in inflationary pressure. However, equity investors are anticipating a soft landing in the economy and modest rate hikes later this year.

This dissonance has led equities to move in sync with bonds as investors focused on the recession. This could send equities down if the ECB continues to be hawkish.