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Investing.com -- European equities may be headed for a renewed downturn, Bank of America (BofA) warns, as markets are now pricing in an overly optimistic scenario on growth and policy uncertainty.
Following a sharp rebound since early April, BofA expects the rally to reverse as macro headwinds re-emerge and investor assumptions prove too bullish.
“The strong 15%+ rebound in European equities since the April 9th low has been aided by two key catalysts,” the analysts wrote, including “continued resilience in the macro data” and “the perception of fading policy uncertainty.” However, they argue that both drivers are on increasingly shaky ground.
On the macro side, BofA expects the recent strength to fade as the effects of reciprocal tariffs begin to bite and front-loaded activity slows.
“We expect a further 3-points downside for the global PMI to 48 by Q3,” the note said, pointing to a decline that would reflect weakening global demand. Regional growth projections from the bank’s economists imply an even more pronounced fall in global PMI.
Markets are also assuming a rapid decline in policy uncertainty, but BofA sees that view as overly complacent.
“While the European policy uncertainty index has spiked to a new all-time high of 710 in April, markets are priced for uncertainty to fade again rapidly, effectively discounting a decline to 230, the lowest level since March 2024.”
The bank agrees that the peak in uncertainty may have passed but doubts the speed of its decline will match investor expectations.
“We agree that the peak in policy uncertainty is likely behind us, but we are doubtful that uncertainty will decline as precipitously as discounted by the market,” BofA said.
Taken together, the Wall Street firm sees significant downside ahead. Its macro assumptions imply roughly “15% renewed downside for the Stoxx 600 to 460 by Q3”, and more than 10% renewed underperformance for European cyclicals relative to defensives.
BofA recommends exposure to sectors with positive correlation to uncertainty, including Food & Beverages, Pharma, Personal & Household Goods, and Utilities.
Conversely, it remains underweight sectors such as Construction Materials, Banks, Capital Goods, and Diversified Financials.