Beating Wall Street May Be More Than a Blip for European Stocks
European stocks are entering the second half of the year on a strong footing.
Even after three straight months of gains, a growing number of strategists and investors are turning bullish on the region’s equities. Helping sentiment are reports pointing to an economic bounce, unprecedented stimulus measures and optimism that easing lockdown measures won’t lead to a second wave of coronavirus infections.
That’s building a case for European equities to continue a rare outperformance over peers in the U.S., where infections are on the rise in several states. Both the Stoxx Europe 600 Index and the Euro Stoxx 50 Index have outperformed the S&P 500 benchmark since mid-May, and are on track to beat Wall Street for the first full month since last September, helped in part by a rotation into cyclical and value shares.
“I absolutely agree with the growing positive view on European equities,” Chris Dyer, director of global equity at Eaton Vance, said by email. “From a relative valuation perspective, the discount that Europe trades at versus the U.S. has expanded. Regarding how long can Europe outperform the U.S. stock market, the answer is that this could extend for several years.”
Even after a rally that has recouped more than half of the pandemic-spurred losses through March, European stocks continue to trade near a record discount on an estimated price-to-book value basis versus their U.S. peers. At the same time, institutional money is returning to the region after missing out on the initial rebound.
Strategists at BlackRock Inc., the world’s largest asset manager, are considering upgrading European equities from their current underweight stance, joining market participants at Goldman Sachs Group Inc., Morgan Stanley, Bank of America Corp. and Eaton Vance in turning more optimistic about the region in recent weeks.
Positive PMI data trends are validating early investor optimism about an economic recovery, with euro-area figures for June beating forecasts and France even returning to expansion territory. With those priced in, further signs of healing may be needed for markets to move higher. That could come from continued easing of lockdown measures in countries including the U.K., which is set to reopen pubs, restaurants and cinemas in July.
Some indicators still point to more scope for gains. Despite the market bounce, sentiment in Europe remains deeply negative, and Barclays Plc strategist Emmanuel Cau notes that overall positioning remains cautious.
“Amid elevated tail risks and the looming negative summer seasonality, the lack of widespread investor participation in the rally continues to provide some cushion to equities and could give legs to the rally, in our view,” he wrote in a note Friday.
Historically too, Europe is entering prime time. July is the period that the Stoxx 600 has posted its biggest monthly gain on average over the past decade. And it’s chasing up a May advance with one in June for the first time since 2005.
Still, there are plenty of headwinds that could mar the rosy picture for Europe. Bluebay Asset Management chief investment officer Mark Dowding worries there’s complacency about the economic trajectory and the spread of the virus, noting scope for further downward revisions to growth forecasts. Beyond that, there are also Brexit negotiations, trade tensions and unified approval for the European Union recovery fund to contend with.
Not that such obstacles have stopped bulls so far. Among regional markets, Denmark’s OMX Copenhagen 25 Index has fared the best in the first half of the year. Thanks to a heavy weighting of health-care shares, it’s the only European benchmark to post gains, up 7.1% in the period. Defensive darling, the Swiss Market Index has also outperformed, down 5.4% versus a 14% drop in the Stoxx 600. Germany’s DAX Index is down 8.8%.
Sector-wise, defensives are ahead on the year, but they’re losing their advantage. Although tech and health-care shares are the only sectors in green in 2020, cyclicals such as carmakers and miners have led gains since mid-May.
Strategists are split on the best industry exposure to have in the coming months, following the strong rotation. Bank of America, Barclays and Morgan Stanley still favor cyclical stocks, while JPMorgan Chase & Co. and Citigroup Inc. recommend defensives.
Europe’s recent outperformance against the U.S. also comes amid growing concerns that America’s economic rebound will be stifled by hotspots of fresh coronavirus cases.
“The jury is still out whether Europe is going to be a multi-year investment or a trade for this year,” Wei Li, head of investment strategy at BlackRock’s iShares EMEA, said by phone. “The reason for us in warming to European equities is the relative success that Europe has had in controlling the virus’s spread compared to the U.S. and more prudence in opening up.”
©2020 Bloomberg L.P.