Corporate profits, economic difficulties become "obstacles" European stocks outperforming US stocks hopes increasingly dim

According to the information obtained by Zhitong Finance APP, after a brief period of outperformance, the hope for European stock markets to gain an advantage over the US stock market is fading, as concerns about economic slowdown are putting pressure on corporate profit prospects.

The European market could have benefited from investors moving away from large tech stocks, but they have instead turned to undervalued sectors in the US market. Investor preferences are being driven by data showing the resilience of the US economy and expectations that the Federal Reserve will cut interest rates earlier and more aggressively than previously expected.

On its own, the performance of the European stock market looks strong, with the Euro Stoxx 600 index hitting a historic high. Nevertheless, the index's performance in August still lags behind the S&P 500. On an annual basis, the index has underperformed by nearly 9 percentage points year-to-date in 2024, marking the second consecutive year of poor performance.

Evgenia Molotova, Senior Investment Manager at Pictet Asset Management Ltd., said, "Despite high valuations, the US stock market remains more attractive because of its higher earnings growth potential."

Previously, concerns about a potential economic downturn in the US triggered selling in early August, with tech stocks particularly hard hit as investors questioned whether valuations had exceeded the benefits of heavy investments in artificial intelligence. However, as concerns eased, global stock markets are rebounding.

After some component stocks of the "Big Seven" US tech giants like Amazon (AMZN.US) and Google (GOOGL.US) reported disappointing quarterly earnings, European stock markets initially seemed to be one of the biggest beneficiaries of investors fleeing tech stocks.

A survey by Bank of America in July showed that inspired by the first rate cut by the European Central Bank, a net 60% of fund managers expected European stock markets to rise in the medium term. However, the situation turned more pessimistic in August.

Investors are increasingly turning to previously overlooked areas of the US market. In August, equal-weighted indices like the S&P 500 (which reduces the weight of tech giants) outperformed the Nasdaq 100 index for the second consecutive month, marking the longest outperformance since the end of 2022.

Similarly, there was a brief optimism in European stock markets, with the region seeing inflows of $500 million over two weeks after 13 consecutive weeks of outflows. However, according to data from EPFR Global cited by Bank of America strategists, this trend reversed in the seven days ending on August 28, with outflows of $800 million.

The economic growth prospects in Europe are one of the biggest challenges. Germany's GDP shrank in the second quarter, with particularly low sentiment in the main industrial sectors.

An index from Citigroup shows that since June, economic data across the entire Eurozone has been increasingly disappointing, contrasting sharply with the recent economic recovery in the United States.

Beata Manthey, a stock strategist at Citigroup who favors US stocks, said, "When you are worried about growth, you will choose the part of the market that can bring growth."

Manthey pointed out that she needs to see upward revisions in corporate profit expectations and a reduction in political uncertainty to be more optimistic about the stock markets in the region. Current data shows that since June, analysts' expectations for 12-month profits of the Euro Stoxx 600 index have remained relatively flat, while expectations for the S&P 500 index continue to rise.

Despite this, some investors believe that Europe still has the potential to outperform the broader market due to its persistent valuation discount. According to compiled data, the expected P/E ratio of the Euro Stoxx 600 index is around 14 times, compared to 21 times for the S&P 500 index.

Guy Stear, Head of Developed Market Strategy at East Capital Investment Research Institute, said, "We have good reason to believe that the performance of European stock markets should be less volatile than that of the US stock market, and perhaps slightly stronger, because the starting point of valuations is very different."

However, Stear emphasized that to support continued investment in European stock markets, optimism about economic growth and corporate profits before 2025 is needed.

"Will there be catalysts immediately tomorrow? Probably not," Stear said