European equity outperformance is unlikely to last without fundamental changes, according to the BlackRock Investment Institute.
Strategists at the world’s largest asset manager have refrained from upgrading European equities to overweight despite a strong bout of performance year-to-date.
“European equities had a flash of outperformance over the US this year and we see bright spots, but the region needs structural reforms to outshine the US,” the BlackRock Investment Institute said in a recent note.
“What’s needed to ignite an investment renaissance? We think more business-friendly policies and deeper capital markets are required for a broad overweight to European stocks,” the note added.
European stocks have lagged US stocks for the better part of the last two decades, with the MSCI Europe index up 241.3% versus 679.4% from the S&P 500 over the past 20 years.
However, the MSCI Europe index is up 27.24% year-to-date in US dollar terms, versus a 15.3% return from the S&P 500 index over the same period.
As such, the asset class has started to garner attention from global investors after years of underperformance.
BlackRock’s strategists noted that Europe’s long underperformance has led to lagging European stock valuations where every sector trades at a discount to its US equivalent.
They said: “What would it take for Europe to take a sustained lead? Reforms addressing long-held challenges, creating a more business-friendly environment and deepening its capital markets, in our view.”
According to the strategists, Europe needs to deepen its capital markets to help lower the cost of capital and make Europe a more attractive destination to invest.
They added that it needs to channel more household savings into productive savings, where European households hold a third of their financial assets in cash, twice that of the US.
“The key is turning savers into investors to help develop capital markets, in our view,” they said. “That could create a positive feedback loop – greater wealth could spur stronger consumer spending and thus boost growth.”
“We are neutral European stocks but see many selective opportunities,” they said. “We don’t think Europe needs total success on every front to turn a page, just a dedication to pushing forward reforms and not just in crisis moments.”
On a more granular level, the strategists have a preference for the healthcare sector, which they argue benefits from strong cash flows and AI adoption.