EU stocks surge on falling inflation, Fed support, and earnings

European equity markets are experiencing a resurgence of investor confidence, driven by a confluence of factors including diminishing inflation anxieties and the anticipation of sustained central bank support. Fund managers are increasingly gravitating towards a scenario of economic resilience, with a growing belief that accommodative monetary policies, particularly from the U.S. Federal Reserve, will effectively cushion any slowdown in global economic activity. This sentiment shift indicates a broader recalibration of risk appetite and strategic positioning within the European investment landscape.

EU Exceptionalism Tempered, Optimism Rises

The prevailing narrative of “EU exceptionalism,” which had gained prominence amidst earlier trade tensions, has now been tempered. While concerns regarding political instability and stagnant earnings growth had previously tested European companies’ outperformance potential against the U.S., the overall sentiment towards European equities has significantly improved. A notable increase in the net percentage of respondents expecting near-term upside signals a more optimistic outlook, with a substantial majority anticipating mild gains in the coming months and a dwindling proportion forecasting downside risks.

Earnings Growth Fuels Optimism

Underpinning this renewed optimism is a strong conviction in the continuation of positive earnings revisions. A significant majority of European fund managers identify robust earnings as the primary catalyst for equity appreciation, significantly outweighing concerns about earnings downgrades acting as a catalyst for market corrections. This focus on fundamental performance suggests a market increasingly driven by corporate profitability rather than broad macroeconomic fears.

Stagflation and Recession Fears Ease

Concerns about stagflation, characterized by persistent inflation and stagnant economic growth, have also eased considerably among investors. The proportion expecting this scenario has fallen, with more participants anticipating a gradual decline in inflation. Concurrently, expectations of a global recession have moderated, with a substantial majority now forecasting a “soft landing” as the most probable outcome. This shift reflects a growing belief in the effectiveness of policy interventions to navigate economic headwinds.

Fiscal Expansion and Trade Tariffs

The perceived drivers of European growth acceleration are increasingly centered on fiscal expansion, particularly within Germany, rather than stimulus measures from China or the European Central Bank’s monetary policy. Furthermore, a significant portion of investors believe that risks associated with trade tariffs are now largely priced into the market, diminishing their importance as a primary concern for the near future. This suggests a greater focus on domestic economic drivers and a reduced sensitivity to external trade-related shocks.

Shift Towards Defensive Allocations

Despite the positive outlook on earnings, European investors are beginning to reassess their portfolio allocations. There is a discernible trend towards increasing defensive exposure, indicating a preference for more stable assets, far outweighing concerns about missing out on potentially higher returns from more volatile cyclical investments. This rebalancing suggests a strategic shift towards capital preservation amidst evolving market conditions.

Sector Preferences and Overweights

Within this revised allocation strategy, the healthcare sector has emerged as the most favored for the upcoming twelve months, supplanting financials. Industrials, utilities, and construction also feature prominently in overweight positions, signaling a diversified approach to growth opportunities. While banks retain some appeal, enthusiasm for the sector has cooled. Conversely, energy, automotive, and media sectors remain the least favored, with the highest net underweights.

Geographic Preferences: Germany Leads

Geographically, Germany continues to be the preferred equity market within Europe, underpinned by the sustained belief in fiscal stimulus as a key growth catalyst. Spain ranks second in investor preference, benefiting from resilient earnings performance in its banking and utility sectors. France, however, has fallen in ranking due to persistent political risks, highlighting the impact of geopolitical stability on investment decisions.

Cautiously Constructive Outlook

In summary, as the year draws to a close, European fund managers are displaying a cautiously constructive stance. The abatement of trade tensions, coupled with supportive fiscal policies—especially from Germany—and an improving earnings environment, is revitalizing the continent’s equity narrative. With diminishing fears of a global recession and a more accommodating central banking stance, investors appear poised to engage with risk, albeit with a strategic recalibration towards more defensive sectors and favored geographies.