Global hedge funds are increasingly investing in European stocks and reducing their exposure to North American markets. This shift is driven by ongoing discussions about the high valuation of U.S. equities, according to Morgan Stanley's proprietary data.
Despite the STOXX 600 in Europe seeing a 6.5% increase this year, it still trails behind the S&P 500's 9.6% rise. In comparison, last year the S&P 500 doubled the performance of the STOXX 600 with a 24% rally.
Currently, the S&P 500 is trading at 21 times forward earnings estimates, whereas European stocks are more attractively priced at 14 times, as shown by BofA Securities.
Morgan Stanley reports that hedge funds have participated in buying European equities in nearly 70% of trading sessions since the Euro STOXX 600 started its rally in mid-January. This has increased their portfolio exposure to Europe from below 17% at the end of 2023 to approximately 19%.
Investors are predominantly adding long positions in Europe, with a positive outlook on share prices. Their preferred sectors include information technology services, industrial conglomerates, semiconductors, electrical equipment, and life science tools and services.
As a leading global prime brokerage, Morgan Stanley monitors its clients' capital flows to identify investment trends. The shift towards European equities reflects a broader sentiment that U.S. stocks are overvalued compared to global markets.
Morgan Stanley's equity strategist, Michael Wilson, suggests that any further increase in U.S. equity valuations would require improved earnings forecasts. He attributes the recent rally to more lenient financial conditions and a decrease in the cost of capital following the Federal Reserve's dovish stance in the fourth quarter.
However, BofA Securities' strategists argue that U.S. stocks may not be overly expensive when considering factors like the S&P 500's heavy reliance on the thriving tech sector, the stability of U.S. earnings, and the economic outlook for both regions.
Goldman Sachs' portfolio strategy team also sees potential for Europe to narrow the valuation gap with the U.S., citing the current discount as historically significant.
