Patrick 00:00

Welcome back to the Barclays brief. It’s Patrick here. I'm very excited today to be joined by Emmanuel Cau. He's our Head of European Equity Strategy here at Barclays Research. Emmanuel, thanks a lot for joining us today.

Emmanuel 00:12

Hey, Patrick. Thanks very much for having me on the pod. And it's great to be here.

Patrick 00:17

 Great. So here we are. It's the 1st of September. Summer is sadly drawing to a close. Investors will be returning from the beach to their Bloomberg terminals, so it felt like a good time to catch up and take stock of where markets stand.

Emmanuel 00:30

Yeah. Sounds good Patrick.

Patrick 00:32

Okay, so one of the standout stories this year has been the performance of European equities, which have surprised many investors. Given that we have this backdrop of trade tensions, geopolitical uncertainty and question marks around growth.

So, Emmanuel, if we were to rewind to the start of the year, few would have maybe predicted the strength we've seen in European equities. What do you think is the single biggest reason for that strength in European equities?

Emmanuel 00:56

Well, you are right Patrick. It was all about AI and renewed US exceptionalism at the start of the year. And Europe was again off the radar. After a brief period of shine during 2025, as somewhat provocatively we title our European 2026 equity outlook ‘More than Just AI’ on the view that some positive for the region were overlooked by investors. Now pretty much nine months into 2026, European equities are performing pretty much in line with the US, up 11-12 percent. And I don't think Europe’s good showing is due to one particular factor, but rather a number of tailwinds coming up together, improving market breadth and investors looking for portfolio diversification beyond big tech has definitely helped Europe, particularly in recent months, where we saw sharp unwind of momentum trades. Investors realized that the US and many Asian equity indices are predominantly driven by tech. So they all moving closer together basically, while Europe is less correlated to the AI narrative. At the same time, it's fair to say that the resilience of European growth has surprised many, including ourselves. And this is despite the energy squeeze coming from the war in Iran.

And like in the US, Europe is entering a manufacturing and investment boom, which has led to a strong earnings recovery in 2026 after three years of stagnation. And finally, we are seeing a broad value style revival with commodity sectors and banks, which is key sector in Europe strongly outperforming. And as I always say, Patrick, if banks are fine Europe is fine.

Patrick 02:34

Okay. So, diversification, resilience of growth and that sort of value style revival. You talked about being key to this European strength. But another theme that we talk about when we catch up is about the difference between earnings growth and the re-rating. So are we now entering a phase where earnings growth has to take over from valuation expansion to keep these European stocks going up?

Emmanuel 02:58

Well, maybe I should have been a bit more nuanced here, Patrick, because multiples have been creating that this year and do not look that extended. In fact, European equities have largely performed in line with strong earnings. But yes, in the current regime of higher for longer rates, which by the way of fixed income strategies, expect to continue. It is hard to see valuations doing the heavy lifting, although as long as yields are going up for the right reason, it should be a constrained valuation. But yes, we are walking a fine line here. Given all the moving parts with fiscal dominance and higher term premiums becoming a bigger contributor to the rising yields. So it is very much earnings that matter for equities. And regarding the longevity of the cycle, we are fairly optimistic. Growth indicators remain well oriented, particularly in manufacturing and in Germany.

Base effects from a year ago are turning more favourable as a drag from tariff and a strong Euro are dissipating. Oil prices high but not too high. So, energy earnings are going up without hurting other sectors. And we are seeing emerging evidence of AI CapEx driving productivity higher and lifting margin for some sectors. And finally, higher rates are also a positive for banks earnings, which is one of the biggest contributor to earnings growth for the overall market in Europe.

Patrick 04:22

Well, let's dig into the rates because obviously that is the topic du jour. Investors often assume that higher yields are bad news for equities. You have typically argued the relationship is just a bit more nuanced than that. So what matters more for stocks right now? Is it where rates are or why rates are moving?

Emmanuel 04:40

Well, you should always take equity strategists view on rates with a pinch of salt Patrick. And these days everybody seems to have become a fixed income expert. But our work showed that the reason for the moving yields and the speed of the move typically matter more for equities than the actual level of yields. And right now, bond investors are mostly concerned about the fiscal dominance, which is weakening central banks inflation fighting credibility. And that's why the term premium has gone up across the board as most developed economies are running massive deficit without a strong commitment to improve fiscal trajectory. But why this is a concern. The rise in yields we have seen in the post pandemic era has been coming with a strong rebound in nominal growth. And all this fiscal spending basically is pushing up growth and inflation, which is feeding into strong earnings. So basically, some inflation as long as it is under control is not a bad thing for equities. But as we have seen most recently, equities have become again more sensitive to interest rate volatility. So, we are probably near the danger zone here for equities.

Patrick 05:48

OK, so we're near the danger zone. But I like what you said and the work you've done around the speed in the move on yields mattering more than the actual level of yields for European equities. Let's pivot now and think about the US versus Europe. Now it's a typical question I know you get asked it all the time. But Europe seems to benefit as a bit of an anti AI trade. So, if you're pitching European equities to a global investor today what do you think is the strongest argument for them owning more European equities rather than simply buying more American equities.

Emmanuel 06:21

Well let's be clear here US equities weigh almost two thirds of the global equity market cap. So, they will always be the dominant share of any global investor portfolios. And European investors typically feel like they’re in the passenger seat, as it is the US that is driving the show. And believe me, Patrick I know the frustration. Now once you accept that, you can still find some reasons not to dismiss Europe. And you're right, there is certainly an anti-tech angle here as Europe is less of a direct proxy for the AI narrative than the US and many other Asian indices like Korea or Japan. But a lot of the CapEx revival in Europe is ultimately driven by the global AI investment boom. And then we have seen recently the debasement trade hitting the dollar, which means that equity flows are starting to broaden out and a strong currency makes European equities a bit more attractive to US investors. And equally, a weaker dollar makes US equities less attractive to foreigners. And then you have a valuation argument which is relevant in a world of higher for longer rates, as Europe is more value oriented and thus less rate sensitive than the US. And finally, we speak to many active managers who are struggling to cope with a very high concentration of the US indices, while market breadth is wider in Europe.

Patrick 07:39

Yeah, I mean, I think I totally understand why investors would want that diversification angle of Europe. But what do you think has to happen for Europe’s strong performance to continue over the next 12 months?

Emmanuel 07:50

Well, first I think it's all about earnings. We need to see Patrick a continuation of the earnings up cycle. Given there are still many European investors out there who still see Europe as a value trap. Is cheap, but for good reason.

Patrick 08:04

And Q2 earnings in Europe were very strong, right?

Emmanuel 08:07

Indeed. We had a very strong Q1 and Q2. So that's giving hope that there is momentum into the remainder of the year in here. Obviously, some stabilization in oil is important, and the kind of continued resilience of growth is also key. And here I’ve seen progress on German stimulus is quite important for sentiment in Europe. We are seeing more and more green shoot emerging in Germany, but of course we are still early days in terms of implementation and there is pretty high execution risk. And I guess finally a less tech heavy market would be helping too. I'm not saying, Patrick, you have to be bear on AI to be bull on Europe, but there will be a lot of fresh capital driven by AI related issuers that has to be absorbed by in the US, both by the equity market and the rate market, which is less the case in Europe.

Patrick 08:55

Okay, so putting it all together. You've been pretty constructive on Europe for a while now, and being right, I'm sure you get asked this a lot by investors, but what do you think is the biggest reason the European equity story could unravel from here?

Emmanuel 09:07

You know, when you do my job, Patrick, as a European equity strategist, the first question you have to be prepared to answer from clients is ‘what could go wrong with Europe’? And indeed, the list is quite long in the near term. I think the main concerns with overall deficit or is not really specific to Europe, politics and geopolitics. France could be a key focus point for markets into the 2027 presidential election, with negotiations on the budget starting soon. I think a lot is priced in and non-already, but the noise won't go away. Germany also has three important local elections in September as the conflict between Ukraine and Russia, US and Iran are wild cards and gas prices have gone up again for Europe, and inventories are quite low into the winter season. And finally, China remains a key market for many European exporters and a growing source of competition at home. So, growth and policy development there are very important as well.

Patrick 10:06

Okay, so if you're thinking about how to trade this backdrop then. So if we move away from well-known European sectors, you talked about banks quite a few times. Which sectors do you think investors are beginning to warm up to that maybe our listeners would be interested in?

Emmanuel 10:20

Look, I think the market is quite polarized. I think financials, banks and industrials are quite consensus and have been strongly outperforming. On the other hand, there is a lot of aversion for the consumer discretionary, consumer staples have been very poor performers. We are starting to see some incoming on that but still very little interest overall. One area of emerging appetite seems to be commodities. I think the backdrop of weaker dollar and still resilient growth and inflation risk. People are looking for trade that could give them a bit of a hedge here. And we are placing a bit more interest on the commodity space right now.

Patrick 10:56

Yeah. It's interesting that commodity space is actually something we've talked a lot about on previous episodes of this podcast, so listeners should go back and check some of those out. Emmanuel, thanks a lot for joining me today. It's been great to catch up.

Emmanuel 11:08

Thanks for having me, Patrick.

Patrick 11:10

Okay, so while European equities may have started the year as being a little bit overlooked. I think Emmanuel today is arguing that those European equities are now benefiting from a combination of stronger earnings, broader market leadership and an improving economic momentum. And it's not just about being an anti AI trade. The challenge from here, however, is proving that this recovery has further left to run. Thanks a lot for listening to the Barclays Brief. If you like today's conversation, do hit subscribe and we'll be back at the same time next week.