The US dollar’s surge to record highs has significantly impacted European equities.
Since September, the USD trade-weighted index has climbed 7%, pushing the EUR/USD exchange rate close to parity.
This dollar strength has contributed to European equities outperforming global markets by 3% since late December, following a difficult second half of the previous year.
Among sectors, software (ETR: SOWGn) has been the top performer since September, outpacing the broader market by 15%, which exceeds its usual trajectory linked to USD movements. Pharmaceuticals, with 40% exposure to US sales, have underperformed their typical USD sensitivity due to unfavorable stock-specific developments.
Surprisingly, capital goods, a sector generally negatively correlated with USD strength, has outperformed expectations. According to BofA, the sector “has been overshooting its USD-implied trajectory since September,” driven by the over 10% outperformance of defense stocks amid rising expectations for increased European defense spending.
Historically, a stronger dollar leads to negative global macroeconomic surprises, typically appearing after a two-month lag as tighter financial conditions take hold. Recent data indicates global macro surprises have turned negative again, with the impact of USD strength expected to push them further into negative territory in the coming weeks, according to the report.
While BofA holds a bearish outlook on European equities overall, it maintains a tactical Overweight on Europe relative to global equities. Analysts foresee downside risks for the Stoxx 600, predicting a 9% drop to 470 by Q2 2025. However, modest improvements in Euro area PMIs could bolster relative outperformance. Defensive sectors such as food and beverages, along with pharmaceuticals, are key Overweight positions.
BofA notes these sectors “have underperformed due to sustained compression in risk premia to multi-decade lows but stand to benefit when risk premia widen again.”
Conversely, banks and capital goods remain key cyclical Underweights for BofA due to potential pressures from falling bond yields amid weakening global macro surprises.
Analysts also anticipate lower bond yields could drive around 20% outperformance for the real estate sector while leading to a 12% decline for European value stocks compared to growth stocks.
The semiconductor sector is Overweight, with BofA expecting further recovery from its underperformance relative to global growth trends last year. Similarly, luxury goods remain Overweight; however, after a 15% rise since November, further price gains are expected to be limited.
