So far this year, the MSCI EMU index has posted a total return of 15% in dollar terms. The MSCI US index has managed only 12%. Go back to early November, when hopes for Covid vaccines began to boost markets, and the performance gap is even more pronounced. Eurozone equities have returned 44%, compared with 31% for US equities. The eurozone has outperformed despite starting vaccinations later and having a slower start to its vaccination programs. The consequence of these delays is that European countries are only now beginning to ease their restrictions on economic activity. This suggests that eurozone growth has room to surprise on the upside, and that eurozone equities may still have more upside to run. 

As vaccination programs have accelerated and service industries have begun to reopen, opinion polls have rebounded. Data released this week showed that France's business confidence index rose to its highest level in three years in May, with confidence in the service sector on the rise. Similarly, Germany's IFO survey of business expectations showed its strongest reading since January 2011.

As a result, the European Commission's recently updated forecast for annual growth in the eurozone of 4.3% seems too conservative. A figure above 4.5% seems more likely, and possibly as high as 5%.

This suggests that further upside is still likely for the cyclical plays that have led the recent rally: the former "Covid losers," including banks and traditional retailers.

With a total dollar return of 99% since the end of October 2020, eurozone banks have surely already seen the best of their run. However, there are good reasons to believe they may still offer some additional upside.

Traditionally, the performance of eurozone bank stocks relative to the broader index has been highly correlated with the slope of the yield curve. With the European Central Bank promising to keep official interest rates unchanged until inflation is "consistently" on target, the short end of the curve will remain anchored in negative territory well into the medium term. As a result, the slope of the curve and, therefore, the relative performance of bank stocks, will be determined by movements in 10-year yields that have upside risk.

Among the other "Covid losers" that are likely to continue to outperform are traditional retailers. Heavily impacted in the early days of the pandemic, they have recently regained ground at the expense of online retailers. So far this year, traditional retail stocks are up 15%, while online retail stocks are down -7% on average. This trend is likely to continue as European economies reopen.

Finally, the visibility of corporate results has been improving significantly in Europe, with Q1 2021 results far exceeding estimates. (see charts)