INVESTORS are betting that Europe will drive the next leg of the global equity rally, broadening their playbooks as a more expensive US market evokes memories of the dot-com bubble.
Hedge funds are now the most exposed they have ever been to European stocks relative to a global benchmark, according to Goldman Sachs Group data. Mutual funds have also amped up allocations to the region’s equities by the most since June 2020, a recent survey by Bank of America showed.
The prospect of “Europe’s outperformance against US stocks certainly has legs”, Paul Brain, deputy chief investment officer of multi-asset at Newton Investment Management, said in an interview in London.
“US big tech seems fully priced and may run into headwinds from competition and regulation after the recent rally.”
Euro area shares rose by around 4 per cent in March, outpacing their US peers, and investors expect them to keep climbing if a rebound in economic growth revitalises corporate profits. That comes as the artificial intelligence fervour gripping the US market makes the fortunes of the S&P 500 Index increasingly reliant on a group of relatively expensive tech stocks.
Hedge funds’ allocation to Europe versus the MSCI All-Country World Index reached 5.8 per cent overweight last week, the highest level on record, according to the Goldman Sachs data.
GET BT IN YOUR INBOX DAILY
Start and end each day with the latest news stories and analyses delivered straight to your inbox.
Despite Europe’s gains this month, its benchmark Stoxx 600 Index still looks cheap. Its forward 12-month price-to-earnings ratio of about 14 is only slightly higher than its long-term average, according to data compiled by Bloomberg. Even excluding richly valued tech stocks, the S&P 500 is in expensive territory.
Europe’s heavier weighting in more cyclical sectors could work in its favour as economies such as Germany and the UK look set to dodge a prolonged recession and global growth picks up. Any easing in interest rates could also help.
“As interest rates come down, and we get this soft landing, the opportunity for broadening out into some more cyclical parts of the market is improving,” Goldman Sachs’ Peter Oppenheimer said on Bloomberg TV. Tech stocks will perform well, but the strategist sees “better relative valuation opportunities outside the US”.
A drastic reduction in short positioning also shows sentiment towards European stocks is improving, according to S&P Global. Estimated short positions on the region were cut to less than 0.2 per cent of total market capitalisation at the end of last year, the lowest level in at least a decade, and have remained near that level since.
BlackRock’s Europe, Middle East and Africa iShares team, including Karim Chedid and Laura Cooper, are seeing signs that funds from clients are making their way back to Europe.
“We’ve leaned into Europe from a tactical momentum perspective,” they said. “We’re seeing some flows coming back, including from US investors, so we’ve been warming up.”
The BlackRock team remains overweight on US stocks on a longer-term outlook, betting on more gains related to artificial intelligence. Other market participants are convinced of a sustained rally in US stocks, as they expect large-cap names to continue to deliver on earnings growth.
Going by track record, European equities have been underperforming versus their US peers relentlessly since the aftermath of the global financial crisis, with brief periods of relative recovery. The last significant episode of outperformance lasted about four months, between October 2022 and March 2023, and saw the Stoxx 600 beating the S&P 500 by more than 12 percentage points over that period.
The US is also expected to see strong earnings growth this year. Analysts expect profits at S&P 500 firms to rise by 8.3 per cent in 2024, while Stoxx 600 earnings are projected to grow 4 per cent, as indicated by data compiled by Bloomberg Intelligence.
Still, this offers room to catch up, said Nicolas Simar, a senior equity fund manager at Goldman Sachs Asset Management. “There could be some interesting opportunities in the European market,” he said. BLOOMBERG
Keyword added to your list