A new investment choice amid the AI selloff? European tech has a low index weight, and its earnings growth is closing in on US stocks for the first time in more than three years.

Europe is narrowing the gap with the US this earnings season, with profit growth expected to be roughly on par for the first time in more than three years. Data show that analysts expect third-quarter profit for MSCI Europe index constituents to grow 23% year on year, only slightly below the 24% expected for S&P 500 constituents. The last time European earnings outperformed the US was in the first quarter of 2023. Economic resilience in both regions is supporting optimism, but for investors in European stocks it is a welcome shift at a time when doubts about artificial intelligence are rattling nerves over their US peers. The Stoxx Europe 600 index is on track to outperform the S&P 500 in October after lagging for two consecutive quarters. "Europe is becoming a more attractive relative opportunity," said Violeta Todorova, senior research analyst at Leverage Shares. "European equities combine several features: more moderate valuations, improving earnings momentum, and lower concentration in a handful of mega-cap technology companies." Results published so far reinforce signs of a strong earnings season, with overall performance in both regions on track to beat expectations. Dutch chip equipment maker ASM International rose about 4% on Wednesday after raising its sales guidance; Deutsche Bank recorded a similar gain after beating expectations; EssilorLuxottica surged about 16% last week after its results came in better than expected. Compared with the US, the region relies relatively less on technology giants, making it more attractive as the market worries about the sustainability of AI demand. The technology sector accounts for about 9% of the Stoxx 600, versus as much as 38% of the S&P 500. Cheaper valuations are another attraction. The Stoxx 600 currently trades at about 14 times forward earnings, below its February peak of 16 times and close to its long-term average. Since June, the benchmark index has maintained a discount of about 25% relative to the S&P 500. However, this momentum has not fully translated into further gains for the benchmark index higher oil prices and lingering geopolitical tensions have weighed on market sentiment. The Stoxx 600 has struggled to break through again since hitting a record high in mid-August. Consumer-facing stocks have been particularly hard hit this quarter, battered by both weakening demand and inflation concerns. Unilever shares fell 2%, partly due to weakness in its food business and developed markets. Volkswagen fell after swinging to a loss, and luxury companies Kering and Hermes also declined after their respective earnings releases. Todorova of Leverage Shares said the "real test" for European stocks next year is whether earnings growth can spread beyond the energy sector. "We need to see stronger demand, improved corporate investment, and sustained profit growth in industrials, banks, consumer and technology-related businesses." Rob Powell, head of equity strategy for EMEA at BlackRock, said European stocks could also be affected by next week's US midterm elections, but added that the long-term outlook remains solid. "Earnings are in good shape, which gives us confidence that, over the long term, the European economy may be in a relatively favorable position." Citigroup indices show that over the past six months, more analysts have raised European corporate earnings forecasts than cut them, the longest streak of net upgrades since 2022. On the other hand, US corporate earnings forecasts have seen downgrades in recent weeks after sustained upgrades since mid-April. "Investors will favor companies with sustained and stable profitability, not just rapid earnings growth," said Alpesh Patel, managing partner at RootBridge Capital. "As long as the three elements of rising returns on capital, stronger cash flow and upward earnings revisions are broadly present, investors will continue to invest in Europe."