European laggards are rebounding - how far can they go?

Investing.com -- European small caps, telecoms, real estate, German equities and luxury stocks could extend their recent rebound as regional growth improves and crowded momentum trades unwind, according to BofA Global Research.

High-momentum European stocks underperformed their low-momentum counterparts by 14% from mid-June, despite recovering about 5% recently. This followed a 125% advance over laggards between early 2023 and June 2026.

Concerns about returns on artificial intelligence spending drove much of the reversal. Since June, European construction stocks have underperformed by 10%, miners by 15% and semiconductor companies by 20%.

Investors have shifted toward areas left behind during the momentum rally. Real estate, telecoms, Germany, small caps and luxury goods have each outperformed by roughly 3% to 4% since June or July after earlier declines ranging from 20% to 50%.

The rotation has been supported by recovering eurozone growth following the energy shock caused by the Iran war. The region’s composite purchasing managers’ index has climbed more than four points since April to 52, while GDP growth accelerated to an annualised 1.8% during the second quarter.

Macro projections indicate about 10% further outperformance for European small caps, telecoms and real estate over the coming months. German equities could outperform by another 5%, helped by infrastructure spending and improving domestic activity.

Luxury companies may have the most upside, with projected outperformance of around 15% by year-end if global growth remains firm and China introduces further economic support.

Still, the broader European market is viewed cautiously. Profit-margin forecasts are at record highs and equity risk premiums are near 25-year lows, leaving little room for disappointment.

Risks include weaker AI investment returns, renewed disruption to energy supplies and rising corporate defaults. Semiconductors could underperform by another 10%, while lower bond yields may weigh on banks and other value-oriented sectors.