Europe’s Stocks Are Back in the Lead as Stagflation Risks Ease

04gzbj8kp2ap9)[k(lu13yp7_media_dl_2.png Citigroup

Article content

(Bloomberg) — The prospect of peace in the Middle East is setting up European stocks for a standout second half, as investors bet on stronger economic growth and easing inflation.

Article content

After trailing US peers since the war began three months ago, the Stoxx Europe 600 Index is up about 1.5% this month as the US and Iran reached an interim deal to reopen the Strait of Hormuz — a key waterway in energy transportation. The S&P 500, on the other hand, has dropped 1%.

Article content

Article content

Article content

While the deal between Washington and Tehran is far from done and may appear fragile — talks scheduled for Friday were postponed — oil prices have declined nearly 30% in the past month. That suggests investors don’t currently expect a major re-escalation in the war.

Article content

Article content

That bodes well for economy-reliant sectors such as banks, automakers and luxury goods firms. Meanwhile Europe’s lack of big artificial intelligence names is perceived to be an advantage, with the US tech trade faltering on worries the rally has gone too far.

Article content

“The investment case for the ‘buy Europe’ trade is back,” said Raphael Thuin, head of capital market strategies at Tikehau in Paris. “When you invest in Europe you are diversifying away from the risk in tech and so we like our exposure to Europe which we have reinforced recently. This is the right moment to put cyclicals back into portfolios.”

Article content

A slate of market strategists, including at Goldman Sachs Group Inc. and Barclays Plc, have already boosted their expectations for European equity returns this year. Deutsche Bank AG strategists no longer prefer US stocks to Europe, while a Bloomberg survey showed 16 forecasters on average expect the benchmark Stoxx 600 to finish 2026 near its all-time peak.

Article content

Article content

The latest economic readings are also flashing encouraging signs. A Citigroup Inc. index of economic surprises shows European data are starting to inflect higher just as the US appears to be peaking. In the past, this relative trend also marked an era of regional equity outperformance.

Article content

Investors have been quick to rotate into growth-sensitive sectors in Europe. Banks, industrial goods and media stocks were among the strongest performers in the week since the interim deal was announced. The more defensive utilities and telecom stocks have lagged behind.

Article content

Market participants are also shunning high-flying energy stocks as they recalibrate the outlook for oil prices. 

Article content

Morgan Stanley strategist Marina Zavolock said the strait’s reopening is still only partially reflected in European equities, suggesting the possibility for further index gains. She downgraded the energy sector to equal-weight while adding to her overweight in banks.

Article content

“Our feedback suggests that while investors have begun to reflect the memorandum of understanding in positioning, they are also awaiting deal execution / resumption in flows through the Strait of Hormuz, while AI continues to dominate focus,” Zavolock wrote in a note.