European Equity Strategy
Key takeaways
The AI capex boom has led to expectations of a profit bonanza, sharp risk premia compression and a surge in momentum stocks
Monetization is key: pricing power is tested as cheaper AI models gain share and lock-in weakens, threatening commodification
We stay negative on EU equities despite reduced macro risks, given risk to extremely optimistic profit expectations
The AI capex boom has fuelled a powerful momentum-driven rally: the capex splurge has created a macro and market environment unlike anything investors have seen over the past two decades, lifting margin expectations to all-time highs, compressing risk premia close to multi-decade lows, and powering high-momentum stocks to record outperformance.
Is AI a high-margin business? While the usefulness of AI is no longer in doubt, end users’ willingness to pay remains uncertain. Early adoption was boosted by subsidised pricing, but recent price increases by leading model providers have exposed users’ cost sensitivity, with corporates beginning to ration usage and/or shift to cheaper open-source alternatives. Lower-cost models are establishing a global price anchor, while new tools and platforms reduce the barriers to entry, increase price transparency, and limit vendor lock-in. This points to a more commoditised and competitive landscape than implied by record margin expectations, especially given sharply rising input costs, as evidenced by Micron’s results this week.
Is AI momentum starting to cool? US hyperscalers have underperformed the S&P 500 by almost 15% since January, suggesting growing investor unease about expected returns. If monetization falls short, pressure to curb spending could intensify, weakening the AI-driven support for economic growth, corporate earnings, and market momentum. This would affect not only hyperscalers, but also all other cyclical assets that have benefitted from the AI capex surge.
We remain negative on European equities: macro risks have improved with the US / Iran peace deal and the rebound in US jobs growth. However, we see the market as vulnerable to disappointment, given highly optimistic margin expectations. If AI momentum starts to cool, this would likely lead risk premia to widen from current lows, while putting downward pressure on EPS, implying downside for the market. We stay underweight cyclicals versus defensives, as they are close to 30-year highs and discounting further risk-premia compression. Among cyclicals, we see the AI enablers (semis, capital goods and mining) as most stretched. Banks have also benefitted from tight risk premia and high bond yields, and are the biggest sector in the high-momentum basket, raising the risk of underperformance in case of a momentum reversal. Among defensives, staples tend to benefit the most from widening risk premia – and should do well on any AI pull-back.
