Episode Details

Europe's equity rally has surprised many investors. Our Europe Head of Research Product Paul Walsh and Chief European Equity Strategist Marina Zavolock discuss potential outcomes of the broadening market.

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----- Transcript -----

Paul Walsh: Welcome to Thoughts on the Market. I'm Paul Walsh, Morgan Stanley's Head of Research Products here in Europe. 

Marina Zavolock: And I'm Marina Zavolock, Chief European Equity Strategist. 

Paul Walsh: And today, we're looking at whether European equities have more room to broaden – as markets assess the implications of a potential U.S.-Iran deal and a reopening of the Strait of Hormuz.

It's Monday, June the 29th at 10am 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. 

And so, what's driving this? And are we beginning to see inflows into Europe again? 

Marina Zavolock: So, I'm going to give a two-part answer to this. 

Firstly, Europe has a lot of the same exposure as the U.S., 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… 

Paul Walsh: We do. 

Marina Zavolock: Not to the same degree as the U.S., 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 U.S., almost 90 percent of it is made up from these sectors.

Paul Walsh: Yes. 

Marina Zavolock: So, these sectors have moved just as aggressively as many of the AI pockets within the U.S. That's the answer that's kind of similar to the U.S. 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. So… 

Paul Walsh: That’s right. The broadening. 

Marina Zavolock: Yes. So, they... And we've called for broadening recently on the back of this, Iran-U.S. 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 U.S. Now, at this moment, I am sensing that we are getting that pickup 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. 

Paul Walsh: Mm. 

Marina