Morgan Stanley's Chief European Equity Strategist, Marina Zavolock, highlights that European equities are currently on par with the S&P 500 year-to-date, with both indices up approximately 7% to 8%. This recovery follows conflict-driven lows. A primary catalyst for renewed interest in European markets is identified as the discomfort with volatility in the AI trade, leading investors to seek diversifying exposure without entirely exiting their AI positions. The US-Iran memorandum of understanding and subsequent decline in oil prices also contributed to a near-term boost in inflows.
The earnings environment in Europe is considered significantly underestimated, with consensus forecasts projecting European earnings growth above 16% for the current year. Sectors benefiting from inflation, such as banks, real assets, and AI-exposed names, collectively represent about 60% of the European earnings base. Banks, in particular, trade at roughly 10 times price-to-earnings and are showing double-digit earnings upgrades, alongside share buybacks and dividends, making them attractive diversification plays. Furthermore, 55% of the European index's revenues are generated outside Europe, which helps mitigate direct exposure to weaker domestic economic conditions.
The valuation gap between European and US equities has been closing. Europe's valuation discount to the US, calculated on a sector-neutral basis and excluding the Magnificent Seven, saw a decisive narrowing trend beginning this year. Morgan Stanley's top sector picks include semiconductors, metals and mining (led by copper), banks, capital goods, and utilities. These sectors are expected to continue benefiting from the current macro environment, with specific mention of the renewable energy transition as an additional tailwind for utilities. The AI connection is stronger than the index composition suggests, as semiconductors, tech hardware, capital goods, and copper-linked metals and mining, despite accounting for only about 15% of the index weight, are responsible for nearly 90% of its year-to-date performance.
