Fund managers are showing renewed optimism for European equities, driven by diminishing inflation concerns, easing trade tensions, and the prospect of central bank interest rate cuts. A recent Bank of America survey indicates a significant shift in sentiment, with a majority of investors now anticipating a soft economic landing despite some lingering risks.
Key Takeaways
- Investor outlook on European stocks has improved, with a net 37% of fund managers expecting near-term gains, up from 15% in the previous month.
- Concerns about a weakening U.S. labor market have emerged as the top downside risk, cited by 59% of European investors.
- There is a notable shift in sector preference, with healthcare now favored over financials as investors seek more defensive positions.
- Germany remains the most preferred European market due to expectations of fiscal expansion, while political risks have pushed France to the bottom of the rankings.
Shifting Economic Outlook and Fading Fears
The macroeconomic landscape appears less turbulent to European fund managers than it did just a month ago. The prevailing view is shifting away from severe economic distress and toward a more manageable slowdown. This change is largely attributed to expectations of continued monetary easing from central banks, including the U.S. Federal Reserve.
According to the Bank of America European Fund Manager Survey, the belief in a "soft landing" scenario is gaining significant traction. Globally, 67% of fund managers now see a soft landing as the most likely outcome, while only 16% anticipate a significant economic slowdown. This marks a sharp decrease from the 41% who expected a slowdown in August.
Understanding a 'Soft Landing'
A soft landing in economics refers to a scenario where a central bank successfully raises interest rates to curb inflation without causing a major recession or a sharp rise in unemployment. It represents a delicate balancing act for policymakers.
Stagflation Worries Subside
Concerns about stagflation—a challenging combination of stagnant economic growth and high inflation—have also eased considerably. The survey revealed that the proportion of investors expecting stagflation dropped to 41%, down from 58% in the prior month. This suggests a growing confidence that inflation will decline without crippling economic activity.
Despite this optimism, some risks remain prominent. The weakening U.S. labor market has become the primary concern for 59% of European investors. However, this has not entirely dampened growth expectations for the U.S. economy. In fact, expectations for a reacceleration in U.S. growth have reached a 17-month high, with only 44% of managers now forecasting a slowdown, the lowest level since February.
Renewed Confidence in European Equities
While the idea of "EU exceptionalism" has moderated since peaking in July, absolute sentiment toward European stocks has improved significantly. The net overweight position on European equities in global portfolios now stands at 15%, down from a high of 41% in July, reflecting a more balanced view of the region's ability to outperform the United States.
37% of survey respondents now expect European equities to rise in the near term, a substantial increase from just 15% in the previous month. Only 15% see a potential downside, the lowest figure recorded since February.
This renewed confidence is primarily built on the foundation of strong corporate earnings. A commanding 70% of European fund managers believe that positive earnings upgrades will be the main driver of future market gains. Conversely, only 26% view potential earnings downgrades as the biggest risk for a market correction.
Trade Tensions and Fiscal Policy
Investors appear to be looking past the risks of a global trade war. A majority, 52%, believe that tariff risks are now largely priced into the market. Instead, attention has shifted to domestic growth drivers. A significant 74% of managers point to German fiscal expansion as the most critical factor for accelerating European growth, placing it far ahead of stimulus measures from China or policy changes from the European Central Bank (ECB).
Strategic Shifts in Investor Positioning
Despite the positive earnings outlook, European investors are reassessing their portfolio strategies. There is a growing concern about being under-exposed to defensive sectors, which are generally more stable during periods of economic uncertainty. The survey shows that 19% of investors are worried about lacking defensive exposure, compared to just 4% who fear missing out on gains in more volatile cyclical sectors. This is the widest gap between these two concerns in two years.
"The pivot towards defensive sectors like healthcare indicates that while optimism is returning, a layer of caution remains. Investors are preparing for potential volatility even as they position for growth."
Sector and Geographic Preferences
This strategic shift is reflected in sector preferences for the next twelve months. Healthcare has surpassed financials to become the most favored sector. Industrials, utilities, and construction also hold overweight positions in investor portfolios.
While enthusiasm for banks has cooled from 58% in August, 37% of investors still hold a positive view of the sector. On the other end of the spectrum, energy, autos, and media remain the least favored sectors, carrying the highest net underweights.
Geographically, investment preferences within Europe show clear divergence:
- Germany: Remains the top choice for investors, who are banking on fiscal stimulus to drive economic growth.
- Spain: Ranks second, supported by the resilient earnings of its banking and utilities sectors.
- France: Has fallen to the bottom of the rankings due to persistent political risks and uncertainty.
Navigating Future Risks
While the overall outlook is constructive, fund managers remain vigilant about potential tail risks that could disrupt markets. The most cited concern is a potential second wave of inflation, mentioned by 26% of respondents. Another significant worry, cited by 24%, is the possibility of the U.S. Federal Reserve losing its independence, which could lead to a weakening of the U.S. dollar.
What are Tail Risks?
Tail risks are low-probability, high-impact events that are difficult to predict. In finance, they refer to the possibility of a rare event that causes significant losses in a portfolio or market, far beyond what is normally expected.
Sentiment regarding the U.S. dollar is increasingly bearish. A net 47% of global managers expect the currency to weaken over the next year, a sentiment that is approaching historic highs. This outlook could influence international capital flows and investment strategies in the months ahead.
In conclusion, European fund managers are entering the final quarter of the year with a cautiously optimistic stance. The combination of supportive central bank policies, easing inflation, and strong earnings expectations is revitalizing the case for investing in European equities. However, investors are also hedging their bets by shifting towards more defensive sectors, signaling a readiness to navigate any potential economic turbulence ahead.
