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(Bloomberg) — Investors are betting that Europe will lead the next phase of the global stock market rally, broadening the range of strategies as soaring U.S. prices bring back memories of the dot-com bubble.
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Hedge funds now have the most exposure to European stocks ever compared to global benchmarks, according to data from Goldman Sachs Group. Mutual funds’ allocations to regional stocks have also expanded by the most since June 2020, according to a recent study by Bank of America Corporation.
“The outlook for European outperformance relative to U.S. stocks certainly has legs,” Paul Brain, deputy chief investment officer for multi-asset at Newton Investment Management, said in an interview in London. “Large U.S. tech companies appear well priced and could face competitive and regulatory headwinds after recent gains.”
Eurozone stocks rose about 4% in March, outpacing their U.S. peers, and investors expect stocks to continue rising as a rebound in economic growth revitalizes corporate profits. . The artificial intelligence frenzy gripping U.S. markets has made the S&P 500’s fortunes increasingly reliant on relatively expensive tech stocks.
Hedge funds’ allocations to Europe in the MSCI National World Index reached an overweight of 5.8% last week, the highest level on record, according to Goldman Sachs data.
Despite gains in European markets this month, the benchmark Stoxx 600 index still looks cheap. The company trades at a price-to-earnings ratio of about 14 times over the next 12 months, only slightly above its long-term average, according to data compiled by Bloomberg. Even excluding highly valued tech stocks, the S&P 500 is in expensive territory.
Europe’s increased weight in cyclical sectors could work to its advantage as economies such as Germany and the UK avoid a prolonged recession and global growth appears to be picking up. Easing interest rates could also help.
“As interest rates come down and land soft, the opportunities to expand into the more cyclical parts of the market are improving,” Goldman Sachs’ Peter Oppenheimer said on Bloomberg TV. Tech stocks will do well, but the strategist believes there are “opportunities for better relative valuations outside the United States.”
S&P Global said the significant reduction in short positions also indicates that sentiment towards European stocks is improving. Estimated short positions in the region fell to less than 0.2% of market capitalization at the end of last year, the lowest level in at least a decade, and have hovered around that level ever since.
BlackRock’s EMEA iShares team, which includes Karim Chedid and Laura Cooper, sees signs that customer money is returning to Europe.
“We have been leaning towards Europe from a tactical momentum standpoint,” they said in an interview. “We’re seeing some flows come back, including from US investors, so we’re continuing to warm up.”
The BlackRock team remains overweight in U.S. stocks with a long-term outlook, betting on further gains related to artificial intelligence. Other market participants are confident of a sustained rally in U.S. stocks, expecting large-cap stocks to continue delivering earnings growth.
Historically, European stocks have relentlessly underperformed US stocks since the aftermath of the global financial crisis, and relative recoveries have been short-lived. The last significant period of outperformance lasted for about four months, from October 2022 to March 2023, during which the Stoxx 600 outperformed the S&P 500 by more than 12 percentage points.
The US is also expected to see significant profit growth this year. Analysts expect profits for S&P 500 companies to rise 8.3% in 2024, while profits for Stoxx 600 companies are expected to rise 4%, according to data compiled by Bloomberg Intelligence.
Still, Nicholas Simard, senior equity fund manager at Goldman Sachs Asset Management, said there’s room to catch up. “There may be interesting opportunities in the European market,” he said.
—With assistance from Julien Ponthus and Thyagaraju Adinarayan.
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