European equities are seeing a fresh wave of inflows, with Marina Zavolock, Morgan Stanley's Chief European Equity Strategist, noting that the primary driver is investor discomfort with volatility in the AI trade rather than solely a US-Iran memorandum of understanding or a fundamental re-rating of European growth prospects. These investors are seeking diversification without fully exiting their AI positions, making Europe an attractive destination. Consensus forecasts predict European earnings growth above 16 percent for the current year, which is described as genuinely healthy.
Key sectors benefiting from this trend include banks, which trade at approximately 10 times price-to-earnings and are delivering double-digit earnings upgrades, alongside buybacks and dividends. These are identified as key diversification plays and structural beneficiaries of a steeper yield curve. Inflation-sensitive sectors such as banks, real assets, and AI-exposed names collectively account for roughly 60 percent of the European earnings base, positioning the index well for the current macro environment, according to Zavolock. Falling oil prices, particularly Brent crude trading in a supportive $70 to $90 range, are also providing a constructive tailwind by reducing energy cost burdens.
Morgan Stanley's top sector overweights are semiconductors, metals and mining (led by copper), banks, capital goods, and utilities. Notably, approximately 90 percent of Europe's year-to-date index gains are attributed to AI-exposed sectors including semiconductors, tech hardware, capital goods, and copper-linked metals and mining, which together constitute about 15 percent of the index. Europe's valuation discount to the US, when measured on a sector-neutral basis and excluding the Magnificent Seven, has been narrowing since the start of the year and Zavolock believes it has further to close. Furthermore, only 45 percent of European index revenues are generated domestically, mitigating the impact of weak local economic conditions.
