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Stock allocators warm to Europe, but US a concern

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Citigroup's global equity strategists see improvements in Europe's economic outlook as a reason to be more optimistic on European stocks, but they are underweighting the U.S. market, which is now seen as too richly valued.

Citi strategists have upgraded Europe's equity markets to neutral and the U.K. to overweight. Economists at the bank have upgraded their 2014 GDP growth forecasts to 0.6 percent for Europe and to 2.1 percent for the U.K.

"[Emerging markets] and UK appear the cheapest of regions across the world, trading at 11.8 times and 13.3 times trailing PE, respectively," they said.

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Europe's stock markets have been outperforming the U.S. since the S&P 500 hit a two-month low on June 24. The S&P is up 4.8 percent since then, but the Spanish stock market is up 12 percent, and France and the U.K. have gained 10.3 percent and 7.3 percent, respectively.

Of the BRICs, Brazil is up 12.5 and China is up 8.4 percent in that period, while Russia is up 4.3 percent and India just 0.1 percent.

September is typically the roughest month for stocks, and the Federal Reserve is preparing to taper its bond-buying program—seen as a positive for stocks. The S&P 500, up 16 percent year-to-date, also faces headwinds this fall because of the politics surrounding the budget and debt ceiling debates, earnings estimates that will likely be reduced and possible military action against Syria, Citi analysts say.

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Bank of America Merrill Lynch analysts in a note this week pointed out that European equity funds had a record-breaking $12 billion in inflows over the past two months.

Citi strategists pointed to the euro zone and UK PMIs, both above 50 and showing expansion.

"We would caution against getting too excited," the Citi analysts wrote. "Recovery is likely to be modest. Headwinds from de-leveraging and modest external demand are likely to limit the pace of recovery. Many challenges remain for politicians and policy makers. But the outlook across Europe looks brighter. Investor interest appears to be growing too."

(Read More: Enjoy Europe cheer while it lasts, October looms)

Other strategists have been moving money into Europe, as well as looking at ways to play Europe through U.S. stocks with exposure there.

Citi analysts are cautious about emerging markets and continue to lower GDP expectations. They also say risks to EM are possible U.S. military action against Syria and the Fed's potential tapering, which has driven interest rates higher.

—By CNBC's Patti Domm. Follow her on Twitter @pattidomm

  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

  • CNBC Senior Commodities Correspondent and Personal Finance Correspondent

  • JeeYeon Park is a writer for CNBC.com. Follow her on Twitter: @JeeYeonParkCNBC

  • Rick Santelli joined CNBC Business News as an on-air editor in 1999, reporting live from the floor of the Chicago Board of Trade.

  • Senior Producer at CNBC's Breaking News Desk.