European markets are back in favour, thanks to the economy weathering the Iran war better than anticipated, a clearer monetary policy outlook versus other regions and limited exposure to AI-driven volatility.
Europe's STOXX 600 (.STOXX) index is near record highs, company earnings are exceeding expectations, and the euro is at a three-month peak .
It's a sharp contrast to March when the U.S.-Iran war paused "Make Europe Great Again" trades on concern that a fresh energy shock would hurt the economy and fuel inflation.
European equities saw a $2.44 billion inflow in the week to August 12, the largest since the week ending February 25 - just before the U.S-Iran war broke out - LSEG/Lipper data shows.
They have been largely protected from sharp swings in global tech shares due to their limited AI exposure. In comparison, investors that piled into tech-heavy South Korean stocks (.KS11) have had a wild ride with an almost 70% surge in the second quarter followed by a 20% slide so far this quarter.
Also, stronger central bank guidance in Europe compared to the U.S. Federal Reserve and the Bank of Japan, even as Iran war-induced inflation pressures point to further euro zone rate hikes, has reassured investors while the economy has held up well. Citi's European economic surprise index, which measures whether data comes in above or below expectations, (.CESIEUR) is at its highest in over three years.
"As long as inflation doesn't get to the point of causing a recession, inflation is good for equities. And that's the environment that we're in now," said Marina Zavolock, chief European equity strategist at Morgan Stanley. "That's why European equities and the banks in particular are grinding higher."
EQUITIES SURPRISE
Once seen as left behind in the U.S.- and Asia-focused AI rally, European equities are now gaining investor interest in their own right - allowing for a catch-up with gains in other major markets.
European shares have risen about 10% so far this year, while the S&P 500 and MSCI's World stock index are up around 13% each (.SPX), (.MIWD00000PUS).
Support has come from a better-than-expected macro backdrop and various sector-specific factors, such as higher energy prices boosting oil and gas companies. STOXX 600 earnings' growth, however, still trails that of some of its counterparts elsewhere, including the S&P 500.
European stocks still trade at a discount to Wall Street peers. Trading at around 15 times 12-month forward earnings, the STOXX 600 is at a 26% discount to the S&P 500, although that is down from a record 41% in November 2024.
"There are great diversification benefits within Europe, and in a world where the U.S., Asia, emerging markets are very concentrated, one of the values of Europe is you get exposure to other things," said Niall Gallagher, investment manager of the European equities strategy at Jupiter Asset Management.
Sectors that Gallagher has overweight exposure to include banks, as well as electrification and semiconductor capex equipment stocks.
Tech makes up just 10% of the European benchmark, which is dominated by financials, industrials and healthcare. European commodities, industrials and utilities have some exposure to AI - but crucially not only related to that specific trade.
Laurent Clavel, global head of multi-asset at AXA Investment Managers, part of BNP Paribas Asset Management, said he was looking to broaden his multi-asset exposure to Europe.
NOT JUST ABOUT EQUITIES
The euro meanwhile has rallied around 3% from 13-month lows in mid-June to $1.17.
A broadly softer dollar explains some of that move, so does stronger data.
Nomura's head of G10 FX strategy Dominic Bunning said that while "peak bullishness" still seems to be a while off, sentiment around the euro appears to be turning more positive, noting that upward surprises in European economic data contrasted with less positive U.S. data.
Euro zone business activity jumped to an eight-month high in July, but U.S.-Iran war uncertainty continued to cloud the outlook, a recent survey showed.
Analysts also noted that market expectations for another euro zone rate hike sat against uncertainty in the United States, where Kevin Warsh's communication has left markets confused about what the new Federal Reserve chief is prepared to do to contain inflation.
Concerns about U.S. fiscal risks could also benefit European markets. While Germany has ramped up bond sales to fund increased spending, the triple-A rated sovereign is not facing the same degree of concern as some other big economies including the U.S. Government debt as a share of GDP in Germany is just over 60%, while in the United States it is around 120%.
German 10-year Bund yields are 40 basis points higher this year, U.S. Treasury yields have risen 50 bps , .
"A much bigger adjustment could come if we reach a moment where U.S. growth slows down and there are more questions around the sustainability of the U.S. government debt," said Mark Dowding, chief investment officer at BlueBay fixed income.
