Risk-reward on European banks attractive again

All the hot money has been flowing into US equities this year, but Graeme Evans hears that it may soon be heading back over here.

It's been one-way traffic for European funds so far this year as risk-averse investors shy away from political and economic uncertainty in favour of a strengthening US dollar and booming Wall Street earnings.

A stunning 27 out of the past 28 weeks have now seen European fund outflows, with US, Japanese and emerging market equity funds the beneficiaries. US inflows totalled US$19 billion in the past month, including $14 billion last week.

But is the tide about to turn? Barclays certainly thinks so, with the bank's equity research team reckoning that US equity flows versus Europe were "now looking extreme" in an historical context and could reverse in the near term.

They said: "US equity inflows versus the rest of the world have strongly rebounded year to date along with the rising dollar. Both are looking stretched and a potential stabilisation could benefit Europe the most.

"European equities are unloved but we believe they offer improving risk-reward into year-end."

The bank's analysts point to a recent rebound in the euro against the US dollar, which could be a prelude to some reversal in the flow of regional equities.

The prospect of the European Central Bank (ECB) hiking interest rates at some point in 2019, having not done so since 2011, is helping to shift sentiment. The US Federal Reserve has been tightening monetary policy for a while, and may be well down the path of higher rates by the time the ECB moves.

Brexit is still a concern, but Italy's political situation is no longer considered a threat in the same way it was earlier this year.

According to Barclays, European funds have seen outflows of $59 billion since March, wiping out more than the $53 billion of inflows between January 2017 and February 2018.

European banks have been some of the worst performers in the year to date, with the financials sector seeing material outflows this year.

But Barclays now believes risk-reward on European banks is attractive again, helped by a rebound in bond yields and prompting its decision on Monday to upgrade the region's banks to overweight.

This comes after a summer in which funds have turned more defensive, with cyclicals including technology stocks seeing the biggest declines in exposure. Staples and utilities, in contrast, have become more popular.