Bank of America has warned investors that Europe’s recent surge in momentum stocks may be approaching a peak after producing what the bank describes as the strongest momentum-driven performance in more than two decades. In guidance published on Friday, the bank argued that investors should begin rotating away from the biggest beneficiaries of the rally - many linked to artificial intelligence investment - and move into defensive sectors that have underperformed.
According to the note from strategists led by Sebastian Raedler, high-momentum European shares have outpaced low-momentum names by an annualised 40% so far in 2026. That follows gains of 30% in 2025 and 20% in 2024, creating what BofA characterises as a sharply divided - K-shaped - market. In that bifurcated environment, segments tied to the AI spending cycle and resilient growth continued to draw capital, while traditionally defensive areas were left behind.
"The expectations embedded in the winners look excessive," the strategists wrote, highlighting that the elevated performance among certain groups is raising questions about whether valuations and earnings projections can be sustained.
Specifically, BofA identified semiconductor makers, capital goods firms, miners and banks as some of the principal beneficiaries of the momentum trade. In contrast, sectors that materially underperformed included consumer staples, pharmaceuticals, software, luxury goods and autos.
On valuations and earnings, the bank noted evidence that the winning sectors face tougher justification for current prices and forecasts. Consensus projections referenced in the note imply around $800 billion of AI-related capital expenditure over the next 12 months, but BofA cautioned that customer pushback against rising AI costs and a shift to cheaper open-source models could undermine the assumptions supporting that capex wave.
Positioning in client portfolios reflects that caution. BofA said it is maintaining underweight recommendations for European semiconductor stocks, capital goods companies, miners and banks, while favoring consumer staples, pharmaceuticals and software firms as defensive alternatives.
The bank also kept its negative stance on European equities in aggregate. It forecast that the pan-European STOXX 600 index could decline to 560 by the end of the third quarter before recovering to 590 by year-end. At the time of the note, the index was marginally higher at 637.20 points.
BofA acknowledged several factors which have recently eased, including a U.S.-Iran peace agreement and signs of stabilisation in the U.S. labour market, but it warned that markets still price an almost flawless economic outcome. The strategists listed a set of risks that could contest the current complacency in valuations and profit expectations.
Those risks include uncertainty around the restoration of oil flows through the Strait of Hormuz, indications of strain among U.S. consumers, weakening corporate hiring intentions, rising credit default risks and what the bank described as excessively optimistic corporate profit expectations. The strategists pointed out that European equity risk premiums have fallen close to 20-year lows while earnings expectations have risen to multi-year highs.
In sum, BofA said much of the positive news stemming from the global macro resilience and the AI-driven profit boost is already reflected in current prices. Consistent with that view, the bank prefers defensive stocks over cyclicals across Europe. It did, however, single out German equities as an attractive cyclical hedge, arguing that investors are underestimating the impact of upcoming infrastructure spending in Germany.
Despite the selective call for German cyclicals, BofA remains underweight European equities versus global peers, citing weakening euro zone growth momentum and the expectation of wider credit spreads and higher risk premiums in future quarters.
Summary
BofA warns Europe’s momentum rally - the strongest in more than 20 years - may be overextended and recommends shifting from AI-linked winners into defensive sectors, while maintaining an overall negative view on European equities.
Key points
- High-momentum European stocks have outperformed low-momentum shares by an annualised 40% in 2026, after strong gains in 2024 and 2025.
- BofA is underweight semiconductors, capital goods, miners and banks, and prefers consumer staples, pharmaceuticals and software as defensive alternatives.
- The bank remains cautious on European equities overall, but views German equities as a potential cyclical hedge due to expected infrastructure spending.
Risks and uncertainties
- Potential disruption to oil supplies through the Strait of Hormuz could affect energy and related sectors.
- Signs of strain among U.S. consumers, weaker corporate hiring, and rising credit default risk could weigh on cyclicals such as banks, capital goods and autos.
- Challenges to the AI capex story - including customer resistance to rising costs and adoption of cheaper open-source models - could undermine demand for semiconductors and other AI beneficiaries.