Outperformance of European equities may be short-lived

Despite the rally that began in October continuing throughout November, US equities still underperformed their European counterparts in common-currency terms last month. Admittedly, exchange rate effects played a big role in that as the US dollar weakened in general. But we don’t think that the conditions are right just yet for a sustained period of common-currency outperformance by the European stock market.

For starters, despite the recent pullback, we still expect the dollar rally to resume before long on the back of “safe-haven” demand, weighing on common-currency returns of all euro-denominated assets. But even in local-currency terms, we think the prospects for European equities over the next few months are darker than for those in the US. After all, even following a few less-downbeat pieces of survey evidence in the past week or two, the economic outlook still seems much gloomier in Europe than in the US. And earnings expectations don’t yet seem to be reflecting the deeper recession that we are forecasting in Europe. That said, we anticipate that equities in Europe will outperform those in the US later next year as appetite for risk begins to recover and the dollar turns a corner.