Bank of America (BofA) strategists, led by Sebastian Raedler, have issued a warning that Europe's stock market rally, which has been the strongest in over two decades, may be running out of momentum. They suggest that investors should rotate away from artificial intelligence (AI)-linked winners and into defensive sectors that have underperformed. European high-momentum stocks have outperformed low-momentum shares by an annualized 40% in 2026, extending gains of 30% in 2025 and 20% in 2024, creating a "K-shaped" market where AI-driven sectors thrive while defensive areas lag.
BofA analysts believe that the expectations embedded in winning sectors are "excessive," and valuations and earnings expectations are increasingly difficult to justify. They forecast that the pan-European STOXX 600 index could fall to 560 by the end of the third quarter before recovering to 590 by year-end. The bank has positioned its portfolios by maintaining underweight recommendations on European semiconductor stocks, capital goods companies, miners, and banks, while favoring consumer staples, pharmaceuticals, and software firms.
The strategists also highlighted concerns about the $800 billion in AI-related capital expenditure anticipated over the next 12 months. They noted that evidence of customer resistance to rising AI costs and increased use of cheaper open-source models could challenge the assumptions underpinning this spending boom. Additionally, while geopolitical risks have eased and the U.S. labor market shows stabilization, BofA believes markets remain vulnerable because valuations are pricing in an almost flawless economic outcome.
European equity risk premiums have fallen close to 20-year lows, and earnings expectations have climbed to multi-year highs. BofA continues to prefer defensive stocks over cyclicals in Europe, although it considers German equities (DAX) an attractive cyclical hedge due to underestimated infrastructure spending. The bank also remains underweight European equities relative to global markets, citing weakening eurozone growth momentum and expectations for wider credit spreads and higher risk premiums in the coming quarters. Bloomberg also noted independent concerns about AI trade volatility, crowded bets, and leverage risks creating a "treacherous landscape" even as the long-term AI story remains intact.
