"Sell America" Is Dead, but Nobody Told These 3 Popular Funds

Despite earlier enthusiasm for European equities, second-quarter corporate earnings reveal significant underperformance, with European firms failing to materialize profit growth while US companies posted 9% year-over-year gains, notably 40.7% in the communication services sector. This fundamental divergence suggests European markets, currently trading at a premium, are overbought relative to their weak earnings. Investors are advised to shift capital back to the US and avoid European-exposed funds, including the Vanguard European Stock Index Fund (VGK), abrdn Global Infrastructure Income Fund (ASGI), and PIMCO Income Strategy II Fund (PFN), as European stocks are expected to correct to reflect their weaker earnings reality.

Analysis

A significant divergence has emerged between European and US corporate fundamentals, which is not currently reflected in equity market valuations. While US companies reported average year-over-year earnings growth of 9% in the second quarter, European firms posted broadly disappointing results. The disparity is particularly stark in the technology and communications sectors, where US firms, including Alphabet and Meta Platforms, delivered 40.7% earnings growth, while their European counterparts barely achieved 1% growth. Despite this fundamental weakness, European equities, as measured by the Vanguard European Stock Index Fund (VGK), have outperformed the S&P 500 (SPY), indicating a potential overvaluation and risk of correction. This situation creates specific risks for funds with European exposure, such as the abrdn Global Infrastructure Income Fund (ASGI), which has 24.6% of its portfolio in Europe and has seen its historical ~12% discount to NAV evaporate. Similarly, the PIMCO Income Strategy II Fund (PFN) is vulnerable due to its trading at a 5.6% premium to NAV, which could contract sharply in a European selloff, pressuring both its market price and the sustainability of its 11.5% yield.

Key Decisions for Investors

• A critical review of portfolio allocations to European equities is warranted, given the disconnect between rising market prices and deteriorating corporate earnings, which signals a high probability of a market correction.
• Consider reducing exposure to or avoiding specific funds with notable European holdings and stretched valuations, such as the Vanguard European Stock Index Fund (VGK), the abrdn Global Infrastructure Income Fund (ASGI) due to its vanishing discount, and the PIMCO Income Strategy II Fund (PFN) because of its significant premium to NAV.
• Investors should favor US equities, focusing on sectors with demonstrated earnings momentum like technology and communications, which are capitalizing on tailwinds such as the rapid implementation of artificial intelligence.