War in Ukraine Forces European Bulls to Unwind Bets

The recent rise in European stocks has come alongside a broader rally that has lifted U.S. and Asian stocks alike, sending the S&P 500 7% higher since the war began. Many investors and analysts have chalked the global recovery up to bargain-hunting. Some strategists have also suggested shifting into stocks as a hedge against inflation. 

Yet many investors are stopping short of putting full faith in European markets. With the European Union dependent on Russia for around 40% of its gas, many investors have decided that the potential for surging inflation, new supply-chain snarls and even a recession presents too much of a risk. Instead, they are shifting into regions they perceive to be more insulated from the war, including the U.S. and some emerging markets.

Many investors had expected Europe to produce outsize gains in 2022 after two years of U.S. dominance in global stock markets. Compared with the U.S., where indexes are swayed by tech behemoths, Europe’s markets are more dominated by energy companies and bank stocks that do well when inflation is on the rise.

The war has scrambled those bets. Investors yanked $23.4 billion from Western European stock-focused mutual and exchange-traded funds in the three weeks between Russia’s invasion and March 16, data from fund-flow tracker EPFR show. That is more than twice as large as the outflows seen during the first three weeks of the pandemic selloff of early 2020.

Investors, meanwhile, poured $40.5 billion into U.S. stock funds during the three weeks ending March 16, EPFR data show.

James Beaumont, head of multiasset portfolio management at Natixis Investment Managers Solutions, said his team has been forced to reshuffle their model portfolios.

Last year, his team allocated portfolios in line with expectations that the U.S. market—and particularly growth stocks—would outperform. At the start of 2022, they shifted their bets to be more bullish on European and value stocks.   

“We thought we were nicely positioned coming into January and February. Then Putin put a stop to that,” Mr. Beaumont said.

Recently, he said, his team has made the switch to shift back to a neutral stance on Europe. “We don’t feel you can trade in this environment because there could be a peace deal tomorrow,” he said. 

Recent surveys from BofA Global Research show that global fund managers have been unwinding similar wagers. In January, for example, a net 35% of respondents said they were overweight European Union equities, while a net 5% were overweight U.S. stocks. 

By March, the trend had flipped: A net 18% of fund managers were underweight European equities, the survey showed, while a net 12% were overweight U.S. stocks.

“There are all these different anecdotes that are not instilling a lot of confidence,” said

Chris Montagu,

head of global quantitative research at Citi Research. Among the worrisome signs, he said: Downgrades to gross domestic product forecasts for the region.

This month, economists at Citi reduced their global and eurozone GDP forecasts. Economists now expect GDP growth of 2.3% for the eurozone in 2022, down from 3.3% in February. They also raised inflation expectations, forecasting consumer prices would rise 6.5% in the eurozone for the year, versus 4.6% last month.

Data suggests there is little conviction in the recent global stock-market rally, Mr. Montagu said, with index futures showing that investors are expecting more pain ahead for the Stoxx Europe 600 and Germany’s DAX index. Short bets against both indexes—meaning wagers that they will fall—have remained firmly in place, he said. “We’re not seeing new long positions established,” he said.

Investors are also expecting further pain ahead for the euro. Data from the Commodity Futures Trading Commission show that hedge funds on a net basis continue to bet that the euro will weaken against the dollar. 

Viraj Patel,

global macro strategist at Vanda Research, is recommending clients maintain bearish positions against the euro, with oil prices swinging and the European Central Bank raising interest rates at a slower pace than the Federal Reserve.

“The trade shock that we’ve seen over the last couple of weeks is going to weigh on the euro,” he said. “Gone are the days when people thought $1.30 was the fair value.”

Write to Caitlin McCabe at caitlin.mccabe@wsj.com