Comeback for Europe’s Bull Market?

**Paul Walsh** (0:00)
Welcome to Thoughts on the Market. I'm Paul Walsh, Morgan Stanley's Head of Research Product here in Europe.

**Marina Zavolock** (0:06)
And I'm Marina Zavolock, Chief European Equity Strategist.

**Paul Walsh** (0:09)
And today, we're looking at whether European equities have more room to broaden, as markets assess the implications of a potential US-Iran deal and a reopening of the Strait of Hormuz. It's Monday, June the 29th, at 10 a.m. in London.
Marina, it's always great having you on. And for our listeners out there, I think they'd be interested to hear that if we look at Europe's performance year to date, it's now on a par to the S&P. So both indices are up somewhere between 7 and 8 percent year to date. So Europe is starting to stage something of a comeback from the conflict lows. So what's driving this? And are we beginning to see inflows into Europe again?

**Marina Zavolock** (0:52)
So I'm going to give a two-part answer to this. Firstly, Europe has a lot of the same exposure as the US. So that is part of the reason.
I know that Europe has this kind of reputation for not having a lot of tech exposure, but we do have tech exposure, not to the same degree as the US, but let me just give you some numbers here. So we have a number of sectors heavily exposed to the AI capex boom. These are led primarily by the semis sector in Europe, tech hardware, cap goods and metals and mining, specifically copper has a link to AI as well. And those sectors, let's say roughly, they make up at this point about 15 percent weight of our index. And if you look at that year to date performance, that's on par with the US, almost 90 percent of it is made up from these sectors.

**Paul Walsh** (1:43)
Yes.

**Marina Zavolock** (1:44)
So these sectors have moved just as aggressively as many of the AI pockets within the US.
That's the answer that's similar to the US. The answer that's a bit different is that we get from time to time over the years actually, but we had a very big one earlier this year. We get these waves of interest in Europe because investors start to think about diversification. That's right, the broadening. Yes. And we've called for broadening recently on the back of this Iran-US MOU.
But this broadening has other drivers as well. So when we felt this wave of interest in diversification and we saw the flows coming into Europe earlier this year, the driver was initially because the Mag7 was kind of going choppy and sideways. So that just drove diversification out of Mag7 and into equal-weighted S&P, but that also always benefits Europe or tends to benefit Europe. But also we had this wave of interest in real assets earlier this year, and Europe has a higher share of real assets than the US.
Now, at this moment, I am sensing that we are getting that pick up in broadening interest once again, from my feedback with investors. You had this MOU, which was the initial trigger. You have oil prices broadly, they're falling. That's helpful as well. But I think the biggest driver of what's driving this diversification interest at this moment is actually the volatility that we're seeing in the AI complex. So a lot of the feedback I'm getting these days from investors that are coming back to Europe after focusing primarily on the US is, look, I have a lot of AI in my portfolio. I like my AI exposure. I'm not looking to get rid of it or to sell it. But incrementally, I'm a little bit worried about this volatility and I'm looking to broaden my exposure. What do you like in Europe to help me diversify away from this volatility that we're seeing now?

**Paul Walsh** (3:39)
I think that's a great segue, Marina, to my second question because with Europe having really kept pace with the S&P year to date, the question that really is going to be asked is the sustainability of that relative performance. When we think about a backdrop here in Europe of pretty low economic growth, the market continues to be worried about rates hikes given recent inflationary dynamics.
As you've articulated there, tech has played a very significant role here in Europe as well in terms of driving markets higher. You've alluded to it in a few of your comments already, but how sustainable do we see this as being?

**Marina Zavolock** (4:15)
It depends on AI, to be honest with you. If AI starts to really move up at an aggressive pace like it was earlier this year, then it's hard for Europe to help perform given our exposure. But if that starts to move up at a more moderate pace, Europe has a chance to do very well. I think there's a lot of misperceptions when it comes to European equities. Outside of AI, actually, there's quite a lot of strength. Misperception one, you've mentioned it, which is basically, oh, look at our PMIs, look at our GDP growth. Why bother with European equities? I think this is maybe what some US investors may think. But just like in the US, the equities market, and maybe even more so the equities market in Europe, it is not the economy. So we just published our global exposure guide over this past weekend, which Morgan Stanley has been running 29 iterations of this guide. Europe's exposure to Europe is pretty much at historical lows over decades.