Christopher Johnson: European and UK equities have outpaced their US counterparts, and some fund managers believe that Europe’s bull run represents a rotation out of US assets. So, what’s the outlook for the rest of the year? To discuss this and more, I’m joined by Mike Field, chief equity market strategist EMEA at Morningstar. So, Mike, what is your outlook for European and UK stocks for the second half of this year?
What’s Morningstar’s Outlook for European Stocks?
Michael Field: So overall I would say it’s pretty mixed but tilting towards positive, Christopher. On the one hand, you have markets in Europe hitting all-time highs at the moment, which is a bullish sign for markets generally. But also there’s the question of where valuations are behind that. Thankfully we still see some upside to European markets. We think equities in Europe are trading at around a 5% discount, slightly more in the UK. So at least that gives us some headroom to grow in the second half, if indeed the outlook is positive, if the earnings season comes through for Europe as well. There is still a little bit of room for growth, which is good to hear.
Are Rate Cuts Guaranteed?
Johnson: And do you believe that rate cuts in the UK and Europe are inevitable in the second half of this year?
Field: So I think two different scenarios. There are two different areas, if you will. We speak of the UK and Europe as if it’s one, but when it comes to interest rates, at the moment there’s a huge differential between the two. UK interest rates are trading at twice what they are in Europe at the moment. So in terms of expectations, both could see interest rate cuts, most definitely. But I think in Europe, the difference is the ECB [European Central Bank] are at or around where they kind of want to be—that neutral rate of interest that keeps inflation at around 2%. In the UK, they’ve still got a large headroom in terms of cutting. So you should see kind of harder and faster cuts from the Bank of England over the next six to nine months than indeed you’re going to see from the ECB, who have done a lot of the work already, if you will.
Is US Exceptionalism Dead?
Johnson: I also want to get your perspective on; in the introduction I mentioned the rotation out of US assets. Many fund managers are arguing that US exceptionalism is dead. Is that something that you agree with? And do you see this rotation continuing into the second half of the year?
Field: So the answer is, to some degree. I think certainly what investors have woken up to over the last number of months is that putting all your eggs in one basket—the US basket—can be somewhat foolish, or it can lead to a lot of volatility, as we’ve seen with the April “Liberation Day” tariffs. I think that was the catalyst for a lot of investors to move more cash to Europe and acknowledge that yes, it makes more sense to be diversified and indeed have some European exposure. So suddenly that strategy has paid off. And I think investors are very much going to keep that in mind as we move into the second half.
That doesn’t mean that they’re going to ignore the US—it’s still the largest equity market in the world by some share—so it’s still going to see inflows. But I think Europe’s definitely an option now for a lot of investors, and that wasn’t the case before. In terms of US exceptionalism, we can’t replace the Mag [Magnificent] Seven in Europe. We have nothing of that ilk. So, I think yes, to some degree you can see outperformance in US tech—or the growth potential, at least, in US tech is still there, certainly. But one differential maybe is what’s driving the two economies. In the US, you had Bidenomics and debt and things like this driving it. And perhaps what you’re seeing now is the effect of tariffs maybe constraining the US economy a little bit. So, from a growth perspective, can the US grow at the same rate it’s been growing at for the last decade or so? That kind of take on US exceptionalism might need to change over the next coming months.
Is Europe Riding the AI Wave?
Johnson: And what’s your view on how European and UK companies are playing the AI trade? You mentioned that we’re very far behind the Magnificent Seven. But are you seeing any innovation? As you know, AI is effectively taking the world by storm.
Field: I would treat the whole AI growth as more of a global phenomenon. Yes, you mentioned the Mag Seven—obviously they’re at the very forefront of spending and development on the AI front—but it’s that whole tier of companies underneath that. We’ve been on earnings calls with huge numbers of companies saying, “Yeah, we’re integrating AI into our processes,” etc. But I think what a lot of these companies are discovering is perhaps they’ve been too early in adopting AI technologies, and that the returns they hoped to get from these technologies aren’t there—yet. Yes, they will come down the line. But I think the uses of AI in day-to-day life and in day-to-day companies’ operations and processes have been overstated at this point. So, what you could see is continued spending by the likes of the Mag Seven on AI development, but a slightly more sceptical outlook by companies doing day-to-day business as they realize AI isn’t quite where they need it to be to actually revolutionize their businesses as of yet.
Will Europe Benefit From Increased Infrastucture Spending?
Johnson: And finally, Mike, I’m quite interested in your views on infrastructure spending. In the first half of the year, we saw Spain have a massive blackout. We’ve seen discussions around Germany reforming its debt brake, which is going to unlock so much money to invest in infrastructure in different projects in Germany and throughout Europe. So what’s going to happen in regards to infrastructure in the second half of the year? And which companies do you think within Europe are going to benefit from increased spending—in particular, utilities?
Field: We’re quite excited about the German Infrastructure Defense Fund. Look at the magnitude of it. If you look at it relative to Bidenomics and how far the Inflation Reduction Act went to actually stimulate the US economy, the German bill has the potential to stimulate the German economy to a huge degree, and indeed the broader European economy as well. We are quite integrated when it comes to infrastructure. The firms that are central to Europe in terms of infrastructure—data centers, renewables, things like this—they’re very much not just national firms but pan-European firms in terms of the business that they do. So I think the hope is here that the infrastructure spend could go far and wide.
And indeed you mentioned Spanish blackouts. Ultimately that was a huge wake-up call to governments, certainly, but also to utility industries in terms of how much they need to spend over the coming decade to upgrade things like the grid. We’ve come from a place where we’ve had a de minimis amount of renewable energy to a point at which in many countries it’s quite significant nowadays, and the grid really hasn’t caught up with that yet. It’s still geared up for old-school energy usage, not the kind of volatile renewable energy levels that we’re generating nowadays. And now it really needs to catch up, and firms and governments need to spend big on the back of that. So I think there’s hope that that could provide the backbone for European growth in the decade to come.
Johnson: Thank you Mike. This is Christopher Johnson for Morningstar UK.
