Europe’s world-beating equity rally thrives where others falter

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‘I expect European outperformance to continue’ – Amundi’s head of equities.

The spike in bond yields this year may have spooked many global equity investors, but fans of the historically underperforming European market are winning big.

The blue-chip Euro Stoxx 50 Index has surged 11% this year, outpacing other major market benchmarks including the S&P 500 Index and the Nasdaq Composite Index. A predominance of cheap and cyclical shares has turned from bane to boon for Europe as fund managers focus on the recovery from the pandemic and fret over frothy valuations.

The likes of JPMorgan Chase & Co. and Amundi, the region’s biggest asset manager, say that European stocks can outperform the U.S. this year despite concerns over the slow vaccination pace and lockdowns in major economies like France and Italy. Even as it flirts with a record high, the broader Stoxx Europe 600 Index trades at a discount of about 21% to the S&P 500 on the basis of its 12-month forward earnings.

“Europe is indeed well-positioned to benefit from an environment of economic growth accelerating and rising rates,” said Kasper Elmgreen, head of equities at Amundi, which oversees about 1.4 trillion euros ($1.65 trillion) in assets. “I expect European outperformance to continue.”

Value and cyclical sectors rallied strongly in the first quarter, with the Stoxx 600 gauges for autos, lenders, and travel and leisure up around 20%. Europe not only benefits from its discount valuations and the strong presence of banking stocks, but also from being one of the least crowded equity regions globally, according to JPMorgan strategists. The Stoxx 600 has lagged the S&P 500 in all but two years of the past decade.

“We believe that this year the U.S. will not be an outright regional leader. In fact, we think Eurozone should outperform the U.S.,” the strategists led by Mislav Matejka said in a note. “The valuation case remains appealing.”

JPMorgan is overweight on banks, saying it’s the sector that’s most positively correlated to rising bond yields and an economic recovery. Financials have the heaviest weighting in the Stoxx 600 among industry groups, comprising about 16% of the benchmark, compared with around 11% for the S&P 500.

Investors have been putting their money where their mouths are, with allocation to euro-area equities increasing to a net 30% overweight in March, according to a Bank of America Corp. survey, the highest reading since August 2020. By comparison, U.S. stocks had a net 9% overweight.

Historical trends are also supportive of further gains for Europe. The Stoxx 600 tends to post bigger returns in April than in any other month, looking at the average over the past 25 years.

To be sure, Europe’s rally in 2021 faces some risks beyond the current vaccine and virus woes. Bank of America expects stock gains to start fading after the macroeconomic cycle peaks in the third quarter. And Mike Bell, a global market strategist at JPMorgan Asset Management, sees European bond yields rising less than in the U.S., which is why he prefers American value shares.

“I’m frankly a bit surprised that European stocks have done so well,” Bell said in a phone interview. “It’s more of a catch-up trade rather than a rotation.”

For the rally to continue, European companies need to deliver profit growth, said Paul Markham, a global equities portfolio manager at Newton Investment Management. There’s good reason to believe that can happen after a record number of companies beat earnings expectations in the fourth quarter.

Plus, the bungled vaccine rollout is likely just a temporary setback for the region, according to Wei Li, global chief investment strategist at the BlackRock Investment Institute. Once shots are more widely available in Europe, investors can count on accelerated growth through next year, she said.

“I expect a very meaningful economic and earnings recovery,” said Amundi’s Elmgreen. “There is significant pent-up demand at a time when monetary and fiscal policy is very supportive.”