BofA Cautions Europe Momentum Rally, Favors Defensives
Bank of America (BofA) warned that the European equity rally, which has delivered its strongest performance in more than two decades, may be losing momentum. In a note released on Friday, BofA highlighted that high‑momentum European stocks have outperformed low‑momentum shares by an annualised 40 % so far in 2026, representing the strongest momentum‑driven rally in at least 20 years and extending gains of 30 % in 2025 and 20 % in 2024.
The analysts described the market as a sharply divided “K‑shaped” environment. Sectors tied to the artificial‑intelligence investment boom and resilient economic growth—specifically semiconductor companies, capital‑goods firms, miners and banks—have been the biggest beneficiaries, while defensive areas such as consumer staples, pharmaceuticals, software, luxury goods and autos have underperformed significantly. BofA argued that the expectations embedded in the winning stocks are becoming excessive and that valuations and earnings expectations in those sectors are increasingly difficult to justify.
Portfolio positioning reflects this view: BofA has maintained underweight recommendations on European semiconductor stocks, capital‑goods companies, miners and banks, while favoring consumer‑staples, pharmaceutical and software firms.
Regarding AI‑related capital expenditure, BofA noted consensus forecasts of roughly $800 billion of AI‑related capex over the next 12 months, but warned that customer resistance to rising AI costs and the growing use of cheaper open‑source models could undermine the assumptions underpinning the spending boom.
On the broader equity outlook, the bank retained a negative stance on European equities overall. It forecast the pan‑European STOXX 600 index could fall to 560 by the end of the third quarter before recovering to 590 by year‑end, even though the index was marginally higher at 637.20 points on the Friday of the note’s release.
While geopolitical risks have eased following a U.S.–Iran peace agreement and signs of stabilization in the U.S. labor market, BofA cautioned that markets remain vulnerable because valuations are pricing an almost flawless economic outcome. The bank listed several downside risks, including uncertainty surrounding the restoration of oil supplies through the Strait of Hormuz, signs of strain among U.S. consumers, deteriorating corporate hiring intentions, rising credit‑default risks and what it described as overly optimistic corporate‑profit expectations.
The strategists also observed that European equity risk premiums have fallen close to 20‑year lows, while earnings expectations have climbed to multi‑year highs, suggesting that much of the positive news associated with global macro resilience and the AI capex boom is already reflected in prices.
Nevertheless, BofA continues to prefer defensive stocks over cyclicals in Europe, though it sees German equities (the DAX) as an attractive cyclical hedge because investors may be underestimating the impact of forthcoming infrastructure spending. The bank remains underweight European equities relative to global markets, citing weakening euro‑zone growth momentum and expectations for wider credit spreads and higher risk premiums in the coming quarters.