The European stock market “is priced for macro perfection, but the reality is more complicated,” Bank of America (BofA) strategists said in a Friday note.
The rally that began in October of the previous year has driven equities to record highs, pushed the ratio of European cyclicals versus defensives to a 30-year peak, and narrowed U.S. high-yield credit spreads to near historical lows.
This pricing reflects expectations for sustained macroeconomic strength, effortless disinflation, and a seamless cycle of central bank rate cuts.
Supportive data has underpinned these market movements, with U.S. GDP continuing to exhibit strong growth—recording a 2.9% increase in Q1 as per the Atlanta Fed GDP tracker, following growth rates of 4.9% and 3.4% in the previous two quarters.
Further, U.S. payrolls have consistently surpassed expectations, the U.S. manufacturing ISM has rebounded above 50, and core inflation in the U.S. has significantly decreased throughout the second half of the previous year.
Despite these positive indicators, BofA strategists caution that signs of weakness are beginning to emerge in the seemingly perfect "Goldilocks" narrative.
Citing key challenges such as escalating geopolitical risks, a complex inflation picture and “the overhang from thigh monetary policy,” BofA said it remains bearish on European equities and cyclicals against defensives.
“Our macro assumptions imply around 15% downside for European equities as well as 15% underperformance in European cyclicals versus defensives,” they said.