Cheap valuations relative to U.S. equities continue to be a draw, but how long remains is a question. The issue of the U.K. exit from the EU – or Brexit – is another roadblock.
"The relative outperformance of Europe over the U.S. has stopped (and reversed) when the election of (Mr.) Macron was secured," said Lukas Daalder, chief investment officer at Robeco in Rotterdam, Netherlands, in an email. "Positive elements are lowered political risks, cheap valuations and the current relative strength of the European economy. To counter, there is the growing mess called Brexit (which will be painful for both U.K. and Europe), the high earnings growth expectations and the general disbelief that the current string of strong macro data can continue much longer," with Europe normally following the U.S. by a delay of one or two quarters, said Mr. Daalder.
Structurally, executives at Robeco expect the undervaluation of Europe to lead to an outperformance in the longer run, but with the "combination of a strengthening euro and too-ambitious earnings expectations, we do not expect any miracles in the short run," he said.
Concern that the trade may be part way through playing out was shared by David Vickers, senior portfolio manager at Russell Investments in London. The firm has been favorable on Europe for "quite a while (and) what you're seeing now is, from our point of view at least, the evidence of a prognosis coming through."
Mr. Vickers' personal view is that the good story continues to play out, "but my very cynical view is you need to invest prior to that to get the gains" rather than waiting for the evidence. While newcomers to European equities "probably haven't missed" all the upside, they probably have missed a fair bit of it.
Mr. Macron's victory in France removed a "political hurdle which people had rightly so been concerned about," meaning investors "could get more positive about Europe unfettered by political drama," Mr. Vickers said.
However, future potential political drama cannot be ignored, with the potential for Italian elections next year. "At the minute at least it is very unclear as to how that plays out," said Mr. Vickers. "But we are not changing position yet." Executives are not viewing upcoming German elections as a concern.
Eaton Vance Management had also moved early, investing in European equities in what was a contrarian view. However, over the last six months, Edward Perkin, chief equity investment officer in Boston, said that view now "feels more consensus. It's been the right call but has been popular — and I don't like to be with the crowd."
Mr. Perkin said inflows continue, and the firm remains overweight Europe as executives still see better real value vs. the U.S. "But what concerns me now is (it is) no longer about valuations being cheaper — the logic is the European economy is earlier in the business cycle, so (there is) more of an earnings uplift for European corporates than U.S. I think now the burden of proof lies with reality, and the economy does need to improve, earnings do need to go up — it is no longer good enough just to bet on the hope of that happening. In order to justify the increased popularity, it has to come through," he said.