Investors see Further Upside for Eurozone Assets

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The Bank of America European Fund Manager Survey - a closely watched indicator of investor sentiment - shows expectations for further gains in Eurozone assets although inflation fears are growing.

The May survey showed 90%+ of survey respondents expect the EU macro cycle to strengthen, with fiscal policy deemed the most stimulative since 2010.

But investors see inflation as the biggest risk for markets, with a taper tantrum regarded as the second biggest concern.

Investors nevertheless expect European equities to peak next year and see further upside for European cyclicals and financials, an observation that if borne out could drive solid demand for the Euro over coming weeks and months.

"The EUR was bought for most of the past week with real money investors driving most of the latest development. This makes sense, especially when considering that equity-related inflows may be among the main drivers of currency strength," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole.

Only 10% respondents to the survey think that the macro cycle will peak this quarter, with more than 4 out of 10 saying it will not reach a high until at least next year.

Inflation expectations remain elevated, with 82% of respondents believing inflation is set to rise over the coming twelve months, only moderately below the record 94% reached in March.

Inflation is seen as the biggest tail risk for markets, with 35% of investors citing it as the key concern (up from 27% last month). A taper tantrum is seen by investors as the second-biggest tail risk (cited by 27% of respondents), with 4 out of 10 survey participants thinking a tantrum is likely in second half of this year.

The view comes as the UK records a stronger-than-expected set of inflation data for March with most economists saying that while inflation should rise over coming months it will soon fall back.

However, we note there are some voices out there warning that the era of permanently low inflation is in fact coming to an end and investors should prepare accordingly.

"Structural factors such as ageing populations, continued deglobalisation in goods trade and further fiscal activism will reinforce the inflationary dynamic. In the UK, we project sustained core inflation within the 2.5-3.0% range by the middle of the decade," says Berenberg Economist Kallum Pickering.

Investors surveyed by Bank of America nevertheless see further upside for cyclicals and value stocks: two-thirds of investors expect continued outperformance for European cyclicals versus defensives, with a quarter seeing more than 10% upside for cyclicals' price relative as growth rebounds and bond yields rise.

Investor confidence in the European value rally has increased, with 43% of respondents saying the value rotation will continue throughout the year, up from 26% last month.

"We agree with this view and expect 10%+ further outperformance for cyclicals versus defensives and value versus growth over the coming months," says Sebastian Raedler, Investment Strategist at Bank of America.

The survey showed only 1 out of 10 investors expects European equities to reach a peak this quarter, with a plurality thinking a peak is unlikely to be reached until next year.

None of the respondents envisages downside for European equities by year-end, with twice as many projecting single-digit percentage upside than expect double-digit returns over the same period.

The sharp equity rally over the past year has so far not translated into bubble fears, with only a net 4% of participants seeing European equities as overvalued, says Bank of America.