Investing.com - European equities are at all-time highs in absolute terms, and Bank of America (NYSE:BAC) questions whether this outperformance can continue going forward.
The pan-European equity index, the Stoxx 600, has risen to a new all-time high, but last year's sharp underperformance nonetheless leaves Europe's price relative to global equities close to an all-time low.
“We expect both extremes to fade, with soſtening global growth momentum, in line with our economists' projections, putting downward pressure on European equities outright, but a cyclical improvement in euro area growth momentum relative to pessimistic expectations helping European equities to build on their recent outperformance from subdued levels,” analysts at Bank of America said, in a note dated Jan. 31.
Europe's relative performance is best explained by two macro drivers, the bank said, the euro area relative PMI momentum (a gauge of the relative acceleration or deceleration in the euro area economy) and the US 10- year real bond yield (given Europe's value-heavy sector profile).
The gap between euro area and US PMIs stood at 8 points in November, the widest since the Euro area crisis, BoA said, with the undershoot of European equities' price relative to its macro-implied fair value suggesting the market was pricing an even harsher economic deterioration ahead.
This gap has closed to 5 points now, helping European equities' rebound since December.
“We see scope for continued support for European relative to global equities over the coming months on the back of a further improvement in the Euro area's relative PMI momentum, helped by easing credit conditions, a more supportive inventory cycle and a reduced fiscal drag,” BoA added.
This implies nearly 5% further European outperformance following the recent 6% bounce, leading us to retain our overweight stance, BoA said. Yet, this remains a tactical view, with structural performance impediments and scope for lower real bond yields likely to start weighing on performance again by late in the first quarter.
“We remain negative on European equities outright and underweight cyclicals versus defensives: our expectations of soſtening global growth momentum, leading to renewed EPS downgrades and upside to risk premia, is consistent with 10%+ downside for the Stoxx 600 to 470 by mid-year, leaving us negative on the market,” BOA said.
“A further weakening in global macro surprises, in line with our expectations, would also be consistent with around 10% renewed underperformance for European cyclicals versus defensives.”