By Samuel Indyk, Lucy Raitano and Alun John

LONDON (Reuters) – European equities and the euro look set to lose out to U.S. markets in the months ahead, as a stellar run in early 2023 has fizzled out in the face of tepid global economic performance and the AI hype that has brought a sparkle to Wall Street.

The S&P 500 is up 14% year to date and more than 20% from its October low – putting it in a technical bull market. It overtook Europe’s STOXX 600, which is up 9%, in late May for the first time this year.

The currency has acted as a bit of a drag too. In dollar terms, the STOXX 600 is still lagging, having gained 11.3% in 2023, while the euro is up 1.1%. In mid-April, the euro had gained 3.6% against the dollar and the STOXX 600 was up more than 14% year-to-date when priced in dollars.

“Relative to the U.S., European equities are looking less interesting and attractive,” said Bernie Ahkong, co-chief investment officer at fund manager UBS O’Connor Global Multi-strategy Alpha.

“Earlier in the year, we were quite happy to allow more of our long picks to be in European names and have more short picks in the U.S., whereas now we’re saying consciously ‘ok let’s put a higher hurdle on European longs and a lower hurdle on European shorts, and vice versa for the U.S.’.”

Ahkong also highlighted a divergence in the regions’ monetary policy – with more rate hikes and a longer path to any rate cuts expected in Europe – and the excitement around artificial intelligence, as favouring the U.S.

Other fund managers are also flipping away from Europe.

Bank of America’s June fund manager survey, which polled 285 managers with $764 billion in assets under management, showed investors allocation to U.S. equities surged 14 percentage points in June, while allocation to euro zone stocks fell 11 percentage points.

Allocation to technology stocks was little changed in June but, at net 16% overweight, investor positioning was at its highest since December 2021.

“When the technology sector outperforms significantly, the U.S. S&P 500 index will outperform its European counterparts,” said Geoffroy Goenen, head of fundamental European equity management, at fund manager Candriam.

“This key sector represents close to 50% of the current S&P 500 today (if you were to include social media and biotech), whereas in Europe its close to just 10%.”

An equal-weighted version of the S&P 500, which dilutes the impact of the large-cap tech stocks, is up just under 4% in 2023.

TURNAROUND

Part of the European market’s outperformance earlier this year was down to low expectations. European shares traded at their biggest discount to U.S. peers on record last September. But that valuation gap narrowed when natural gas prices fell in January, eliminating much of the concern around the economic outlook for Europe.

Hopes that Europe would benefit broadly from China’s economic reopening also boosted sentiment. In reality, gains were largely restricted to German industrials, travel and leisure and major luxury names, and even those stocks fell to seven-week lows in late May.

“We were in a bit of a sweet spot with European equities through the fourth quarter of last year and first quarter of this year,” said Graham Secker, chief European equity strategist at Morgan Stanley.

“That has started to shift in the last one or two months, as sentiment around China has got weaker again,” he said, also pointing to the outperformance of tech stocks and European macro data rolling over.

The euro zone economy was in technical recession in the first quarter, data from European statistics agency Eurostat showed last week.

“To us, both Europe and the U.S. look ugly,” said Hani Redha, global multi-asset portfolio manager at PineBridge. “But Europe looks even more unattractive than the U.S., because the temporary good data from Europe is really going to turn.”

Citi’s European economic surprise index shows euro zone data has missed expectations for weeks, compared with the United States, where data has beaten forecasts.

This is also playing out in currency markets, where the euro has fallen 1.8% since its early May highs, despite a recovery this week. Barclays analysts say this is due to the “tough macro backdrop” of slowing growth in Europe and in China, and resilient data in the United States.

“The euro is likely to struggle in coming weeks awaiting a more positive global growth trigger, potentially in the form of China stimulus,” they say.

(Editing by Alex Richardson)

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