Rally in European Stocks Looks Most Stretched in Over a Decade

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Warning signs are flashing in European stocks that a rally fueled by optimism about earnings and the economy is running out of road, with an indicator showing that European stocks are overbought being the strongest it’s been for a decade.
The benchmark Stoxx Europe 600 index’s 14-day Relative Strength Index has climbed above 80, suggesting to technical analysts that a period of consolidation lies ahead or that a market top may not be far off.
European stock valuations are now well above their long-term average, and strategists are calling for a near-term pause, with some expecting the growth gap in reported US versus European earnings to temporarily widen in favor of US equities.

Warning signs are flashing in European stocks that a rally fueled by optimism about earnings and the economy is running out of road.

An indicator showing that European stocks are overbought is the strongest it’s been for a decade. Spectacular outperformance by the Stoxx Europe 600 index last year has extended into January, triggering signs the market may have got ahead of itself.

The benchmark gauge’s 14-day Relative Strength Index, a measure of momentum, has climbed above 80, a rare occurrence during the past 20 years. While it’s not bearish for the market over the long term, an RSI reading like this suggests to technical analysts that a period of consolidation lies ahead or that a market top may not be far off.

“Of course with this overbought level you always have the risk of a pullback,” said Thomas Zlowodzki, head of equity strategy at Oddo BHF. “It’s quite clear that European markets can’t continue climbing at that pace.”

For now, trading volumes show that investors still have conviction to buy, Zlowodzki said. The strategist, who sees the Stoxx Europe 600 rising to as high as 650 points points by the end of 2026 from Monday’s close of 611, noted that the bulk of last year’s gains came in the first two months.

So it makes sense that market participants won’t want to risk not being invested if this year follows a similar pattern. “You could miss your yearly performance on that,” he said.

US Growth Impulse

The Stoxx Europe 600 is up 3.2% this year after a 17% surge in 2025. The benchmark has already opened a lead over the S&P 500, which is up just 1.9%. Since cracks started to appear in the idea of so-called “US exceptionalism” last year, investors have rotated their exposure from American assets to the rest of the world.

The dollar bore the brunt of that, while European and emerging-market stocks have been major beneficiaries. As a result, European stock valuations, while still much cheaper, are now well above their long-term average. And US stocks are nowhere near flashing the overbought warning light seen across the Atlantic.

The European rally has been so strong in comparison to the US that Deutsche Bank AG strategists including Maximilian Uleer and Carolin Raab are now calling for a near-term pause.

“We close our tactical preference for European over US equities after another decent outperformance in recent months,” they wrote in a note. “We expect the growth gap in reported US versus European earnings to temporarily widen in favor of US equities. The same is likely to hold true for the economic growth gap between the two regions, due to the enormous impulse for US growth from the triple B,” they said, referring to the US administration’s “big beautiful bill.”

European Equities Are Trading Above Average Valuations

Stoxx Europe 600 still trades at 30% discount to the S&P 500

Source: Bloomberg

Europe has won over investors with interest rates that are already much lower than in the US, while the European Union is ramping up infrastructure and defense spending, led by Germany.

Still, traders are betting on two Federal Reserve rate cuts this year, narrowing the gap with European Central Bank policy. Plus, governments outside of Germany may find it harder to ramp up spending given the fiscal constraints in major economies like France or Italy.

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The risk-on tone is also evident in credit markets. The Markit iTraxx Europe index, which tracks credit default swaps on the region’s investment-grade companies, is trading at around 49 basis points — its lowest level in around four years, according to data compiled by Bloomberg. Meanwhile, the index measuring high-yield credit risk was quoted just below 240 basis points, also a four-year low, the data shows.

Borrowing costs are hovering near all-time lows as well, with the spread on a Bloomberg investment-grade index at about 77 basis points.

German Boost

Roland Kaloyan, head of European equity strategy at Societe Generale SA, isn’t comfortable with the speed at which economically linked cyclical stocks have re-rated higher. “Of course, there’s Germany’s stimulus plan, but we expect it will mostly give a boost to German stocks, rather than to the whole region,” he said.

The European economy isn’t growing fast enough to justify market expectations for earnings to increase by more than 10%, Kaloyan said. To achieve numbers like those would require a strong acceleration in the US and in China.

“Some of the rise of European stocks can be explained by the fact that fund managers need to de-risk and diversify from tech and the US,” he said. “Also there’s a trend these past years of much of the yearly performance being achieved in the first quarter.”

Stoxx Europe 600 Seasonality

Most gains in Europe in past three years were achieved in the first two months

Source: Bloomberg

In contrast with booming US profits, earnings for European companies were flat last year. As a result, the main reason shares in the Stoxx 600 have risen is an inflation of valuations.

This reflects sluggish economic performance in the recent period, with the moderate acceleration in growth seen in 2025 already expected to slow to 1.2% this year. That’s nowhere near the pace of the US economy, which is tipped to expand by 2.1% in 2026.

Gains in Europe have also had little to do with the artificial intelligence frenzy that has powered the record-setting run on Wall Street. With the exception of chip-making machine firm ASML Holding NV, its biggest stocks are mostly pharmaceutical and luxury names.

And it’s not just the main European benchmark that’s looking stretched. Eight sector indexes are also flashing overbought levels: technology, industrials, basic resources, health care, utilities, retail, real estate and financial services. Meanwhile, some thematics are running extremely hot. They include defense plays and strategies targeting low quality, high volatility and expensive stocks.

Overbought European Sectors and Selected Thematics

European stocks are running very hot at start of 2026

Source: Bloomberg, Barclays

For the moment, investor faith in Europe looks intact, with the region’s equity funds attracting decent inflows since the start of the year in comparison to the US. European stocks drew $2.3 billion in fresh money in the week through Jan. 7, while $19 billion exited US peers, according to Bank of America Corp., whih cited data from EPFR Global.

— With assistance from Helene Durand

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