A Contrarian Call on Europe

Market Sentiment & Positioning

• Global equity markets are six months into a historic rally, but professional investor sentiment remains "constructive" rather than exuberant.
• Client positioning data shows net exposure and long-short ratios at the 50th percentile over a one-year lookback, indicating the market is not stretched.
• Significant capital that entered the market in September following summer cash positions has now been deployed, reducing the amount of money on the sidelines.

European & German Macro Outlook

• Market sentiment regarding Germany's new fiscal policy under the Merz government has deteriorated, with many companies reporting no tangible pickup in demand despite government announcements.
• European GDP estimates have been upgraded for the current and next year, while US GDP estimates have been cut.
• European banks offer a value-versus-growth trade, trading at single-digit PEs while delivering double-digit earnings growth and total shareholder returns.
• A strong euro has acted as a significant impediment to aggregate European earnings growth; however, domestic-facing sectors have seen double-digit earnings upgrades.
• European equity outperformance this year is driven by small caps and value stocks, offering a diversification benefit against US large-cap growth leadership.

Volatility & Earnings Dynamics

• Index volatility has compressed to the mid-teens, creating a disconnect with high headline news volatility and persistent single-stock dispersion.
• US Q2 earnings season saw the largest one-day stock moves since 2009; recent European earnings moves were nearly four times the average daily move.
• Opportunity exists to leverage low index volatility to trade single-stock and sector dispersion driven by technology disruption.

Investment Strategies & "Best Trades"

• Chinese AI: Investors are encouraged to invest in Chinese AI, citing a tsunami of domestic innovation, prioritization of tech industries, and emerging self-reliance in silicon.
• German Fiscal Beneficiaries: A contrarian long position on the German domestic economy is recommended, targeting companies benefiting from defense spending and rising real household incomes.

Forward-Looking Economic Data

• Next week's market events include EU CPI data, ISM prices paid data, JOLTS numbers, and US payroll data.
• Portfolio rebalancing at month-end is expected to create market volatility.
• While market comfort regarding the growth outlook has increased, a "wall of worry" regarding inflation remains.