A new investment option under the AI sell-off? European stocks have low technology weight, and the profit growth rate is approaching US stocks for the first time in more than three years

The Zhitong Finance App learned that Europe is narrowing the gap with the US this earnings season, and the profit growth rate is expected to be close to flat for the first time in more than three years. According to the data, analysts expect the profit of MSCI European Index constituent stocks to increase 23% year-on-year in the third quarter, which is only slightly lower than the 24% expected by S&P 500 components. The last time European profits outperformed the US was in the first quarter of 2023.

Economic resilience in both regions has supported optimism, but for investors in European stocks, this is a welcome shift — at a time when concerns surrounding artificial intelligence are stirring the nerves of American peers. The Stoxx Europe 600 Index is expected to outperform the S&P 500 in October after falling behind for two consecutive quarters.

“Europe is becoming a more attractive relative opportunity,” said Violeta Todorova, senior research analyst at Leverage Shares. “The European stock market has several characteristics: valuations are more moderate, profit momentum is improving, and concentration on a few very large technology companies is lower.”

The results announced so far have strengthened the signs of this strong earnings season, and the overall performance of both regions is expected to exceed expectations. Dutch chip equipment manufacturer ASM International rose about 4% after raising sales guidelines; Deutsche Bank also recorded a similar increase after exceeding expectations; EssilorLuxottica (EssilorLuxottica) surged about 16% after last week's earnings report was better than expected.

Compared to the US, the region's reliance on tech giants is relatively low, making it more appealing at a time when the market is concerned about the sustainability of AI demand. The tech sector weighs about 9% in the Stoke 600, and as much as 38% in the S&P 500.

Cheaper valuations are another attraction. The Stoxx 600 is currently around 14 times its forward profit, down from its peak of 16 times in February, and close to its long-term average. Since June, the benchmark index has maintained a discount of around 25% compared to the S&P 500.

However, this momentum did not fully translate into a further rise in the benchmark index — higher oil prices and lingering geopolitical tension dampened market sentiment. After the Stoke 600 hit a record high in mid-August, it has been difficult to break through again.

The quarter was particularly difficult for consumer-facing stocks, which were hit by weakening demand and concerns about inflation. Unilever's stock price fell 2%, partly due to weak performance in its food business and developed markets. Volkswagen declined after turning into losses, and luxury goods companies Kering (Kering) and Hermes (Hermes) also declined after their respective earnings reports were released.

Leverage Shares' Todorova said that for European stock markets, next year's “real test” is whether profits can spread from the energy sector. “We need to see stronger demand, improved corporate investment, and continued growth in profits from industrial, banking, consumer, and technology-related businesses.”

Rob Powell, BlackRock's head of equity strategy for Europe, Middle East and Africa, said that European stock markets may also be affected by next week's US midterm elections, but he added that the long-term outlook remains solid. “The profit situation is good, which makes us believe that the European economy may be in a relatively favorable position in the long run.”

The Citigroup Index shows that in the past six months, the number of analysts who raised European companies' profit forecasts was higher than the number of analysts who lowered their expectations. This is the longest continuous upward and downward trend since 2022. On the other hand, US corporate profit expectations have been lowered in recent weeks after continuing to rise since mid-April.

“Investors will favor companies with consistent profitability, not just rapid profit growth,” said Alpesh Patel, managing partner at RootBridge Capital. “As long as the three factors of return on capital continue to rise, cash flow is stronger, and profit expectations rise, investors will continue to invest in Europe.”