The mood among European fund managers has shifted dramatically. After months of caution, investors are once again positioning for a “Goldilocks” scenario of solid economic growth alongside easing inflation, fuelling a broad return to risk assets. But the optimism comes with a clear caveat: it hinges on geopolitical tensions, particularly in the Middle East, remaining under control, said BofA Securities in its European Fund Manager Survey.
Goldilocks takes centre stage
For the first time since October 2024, a Goldilocks environment has become the dominant market expectation among European investors. A net 37% expect a combination of resilient growth and moderating inflation over the next three months (see Chart 1), while confidence in Europe's economic outlook has strengthened sharply. More than half of respondents expect the European economy to improve over the next year, up from just 11% a month earlier.
Chart 1: What regime do you expect the market to be in over the coming three months? Source: BofA European Fund Manager Survey
Fiscal expansion, particularly in the euro area, is now seen as the main catalyst for stronger growth, replacing hopes for geopolitical de-escalation that dominated previous surveys (see Chart 2).
Chart 2: What do you see as the most likely reason for European growth to accelerate? Source: BofA European Fund Manager Survey
Investors rotate back into Europe
The improved macro-outlook is translating into stronger conviction on European equities. A net 54% of European investors expect regional stocks to rise over the coming months (up sharply from 4% in June), while global investors have also begun rebuilding positions after months of underweight allocations. Over a 12-month horizon, respondents expect European equities to deliver an average return of 6.3%.
However, enthusiasm is not evenly spread. The UK remains the least favoured major market among global investors, with a net 37% underweight, the most negative positioning since August 2020.
Banks become the market favourite
The renewed appetite for risk is triggering a clear sector rotation. Banks have overtaken all other sectors as the market's largest consensus overweight, reaching their strongest positioning since early 2022. Investors also expect cyclical stocks to outperform defensive sectors, reversing last month's more cautious stance.
Healthcare experienced the sharpest decline in investor sentiment, while autos remain the most underweight sector despite being widely viewed as undervalued. Germany is the preferred equity market within Europe, whereas France is the least favoured.
Earnings remain the key driver
Investors continue to believe that corporate earnings will determine whether the rally can continue. Nearly two-thirds see earnings upgrades as the main catalyst for further gains (see Chart 3), while volume growth is expected to be the biggest contributor to profits over the coming year. Artificial intelligence is increasingly viewed as a source of margin expansion and cost savings rather than a direct revenue driver.
Chart 3: What would be the most likely reason for European equities to move higher? Source: BofA European Fund Manager Survey
Geopolitics remains the wildcard
Despite the improved outlook, risks have not disappeared. Middle East instability remains investors' biggest geopolitical concern (see Chart 4), while renewed energy price shocks and inflation are still viewed as the principal downside risks to global growth. The most likely trigger for a market correction would be central banks adopting a more hawkish stance in response to unexpectedly persistent inflation.
Chart 4: What do you expect to be the most significant geopolitical driver for markets over the coming months? Source: BofA European Fund Manager Survey
