Analysis-Investors warm to European stocks eclipsed by Wall Street's AI glow

By Danilo Masoni

MILAN, July 1 (Reuters) - Lower crude prices following the Iran ceasefire are improving the near-term outlook for European equities, but many remain unconvinced this heralds a rotation away from the U.S. after several years of AI-driven earnings growth.

The shift follows a drop in crude prices to near pre-war levels closer to $70 a barrel, as easing concerns over disruptions to supplies through the Strait of Hormuz lifted a key overhang for Europe's energy-importing economy.

TAILWINDS FOR EUROPE

The fall in energy costs is widely seen as a positive for Europe, easing inflation pressures, supporting household purchasing power and boosting corporate margins.

It has helped push the region-wide STOXX 600 index to record levels, while economy-sensitive sectors such as industrials, chemicals, travel, banks and luxury stand to benefit most.

"Lower oil prices strengthen the investment case for Europe, especially against an energy exporter such as the U.S.," Invesco investment strategist Andras Vig said.

"The overweight of cyclical sectors in Europe can also boost relative returns if input costs decline, inflation moderates and global economic growth re-accelerates."

Vig said Europe's attractive valuations and less concentrated markets could appeal to investors seeking greater diversification beyond technology.

The STOXX trades at a 26% discount to the S&P 500, according to LSEG data.

EUROPEAN ETF FLOWS TURN POSITIVE

Fund flows suggest sentiment may be stabilising, but remains skewed to the U.S.

European ETFs saw about $1.5 billion in inflows in the week to June 19, the first positive reading after 10 straight weeks of outflows, according to Morningstar estimates. U.S. ETFs drew in $56 billion, extending a powerful run of inflows.

The central question is whether this could signal a reallocation away from Wall Street, driven by high valuations and heavy concentration in technology, or simply a short-term tactical shift.

Barclays has dropped its bearish stance on Europe, pointing to scope for a broadening beyond U.S. tech, while other investment banks have raised targets for regional stocks.

Nordea senior strategist Hertta Alava said lower energy costs and a rotation into cyclicals could drive near-term flows, but not a "durable reallocation", noting that U.S. growth has proved more resilient and already spread beyond tech.

"So Europe can now avoid the recession, but GDP growth in 2026 is pretty low," she said.

U.S. EARNINGS HOLD THEIR LEAD

S&P 500 earnings are expected to grow 24.5% in 2026 and 18.1% the following year, per LSEG data, well ahead of the STOXX's 14.3% and 11.9%, underscoring a persistent performance gap despite Europe's valuation discount.

"Reduced tail risks should be treated as a one-off level shift, rather than something that might lead to durable outperformance," said UBS strategist Gerry Fowler after several client meetings in Europe and the U.S.

Pictet Asset Management multi-asset strategist Arun Sai said investors are still waiting for clearer evidence that growth and fiscal support are translating into real economic activity.

"I don't think we have enough evidence yet to commit in size to Europe," he said, adding that any broad reallocation would likely require signs that German infrastructure and defence spending are gaining traction in order books and hard data.

Structural challenges also remain a constraint, with weak demand, competition from China and slow fiscal transmission continuing to weigh, according to Edmond de Rothschild portfolio manager Nabil Milali.

He warned expectations may still be too optimistic, flagging risks of further downgrades to earnings estimates. "We still think that the consensus is way too optimistic on EPS," he said.

His firm upgraded Europe to neutral last month, seeing relief from lower oil prices, but continues to favour U.S. and emerging markets, which are key beneficiaries of the AI cycle, given stronger earnings growth.

(Reporting by Danilo Masoni; Additional reporting by Dhara Ranasinghe and Amanda Cooper; Editing by Jan Harvey)