European Momentum has unwound quickly, but fundamentals remain intact

Overview

This report is Goldman Sachs' Europe Weekly Kickstart and focuses on the implications of the recent sharp unwinding of the European equities Momentum factor. It argues that after very strong performance in the first half of the year, the momentum leaders faced profit-taking and the thinning summer liquidity amplified rotation. However, there is no clear evidence yet that fundamentals have materially deteriorated, so this appears to be an adjustment driven by positioning, factor dynamics, and risk appetite rather than a fundamental breakdown of the investment theme.

Core views

Core views include: first, Momentum drawdown is mainly driven by investors exiting earlier winners and rotating toward laggards, with technical and positioning factors having a strong influence; second, the AI investment cycle remains a key source of market leadership concentration over the past year, with Semiconductors under pressure but still having delivered substantial cumulative gains; third, capital-intensive companies benefit from strong demand, low supply elasticity, pricing power, and earnings visibility, with the HALO theme experiencing a near-term setback but continuing to have fundamental drivers; fourth, Aerospace & Defence has outperformed relative to implied Momentum beta returns, while Healthcare is comparatively resilient, and Telecoms and Consumer Discretionary are weaker; fifth, Q2 earnings season will determine whether this drawdown is only a technical adjustment.

Analysis framework

The report integrates factor performance, industry/Momentum correlation, the HALO capital intensity framework, comparison of realized returns versus beta-implied returns, EPS growth and revisions, valuations, flows, volatility, index sales exposure, and macro indicators to assess the nature of the Europe equities rotation. Its focus is not on single-company fundamentals, but on relative performance and portfolio implications at the industry, style, thematic basket, and index levels.

Methodology notes

• Factor analysisMomentum Winners vs. Momentum Losers

  Momentum factor performance is measured using the Barra Momentum Winners and Barra Momentum Losers baskets.

  The report notes that this Momentum pair has fallen about 8% since June 22 and uses that move as a key indicator of whether the market is rotating out of prior winners.

• Theme / Capital intensity frameworkHALO

  Heavy Assets, Low Obsolescence, used to characterize capital-intensive beneficiaries with heavy asset bases and low risk of obsolescence.

  The report argues that HALO captures winner characteristics in the AI and capex cycle; GSSTCAPI is up about 20% year-to-date versus GSSTCAPL, but rising correlation with Momentum has made it more vulnerable to short-term de-risking and factor volatility.

• Industry relative performance attributionFactor-implied vs. actual returns

  Compares each industry's actual performance since the Momentum peak with returns implied by its Momentum beta.

  This method identifies which industries performed better or worse than what factor exposure alone would explain, such as Aerospace & Defence outperforming implied returns and Telecoms underperforming implied beta.

• Earnings validationQ2 earnings delivery test

  Uses earnings delivery to test whether high valuation and high expectations are justified.

  The report emphasizes that consensus EPS growth for Europe in Q2 is 11% year-on-year, about 6% excluding Commodity Producers; successful earnings delivery supports the view that the drawdown was just a positioning reset, while misses could trigger a more persistent style rotation.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• European Momentum

  Core area of observation

  Strengths

  Over the past year it was supported by the AI investment cycle and strong earnings expectations, with leadership concentrated.

  Weaknesses

  After a large first-half gain, it is susceptible to profit-taking and weaker summer liquidity.

  Comparison

  It has fallen about 8% since June 22 and is clearly weaker than the prior trend.

  Risks

  If Q2 earnings miss expectations, a technical pullback could evolve into a more persistent style rotation.

• European Semiconductors

  Core beneficiary of the AI investment cycle and a central area where this correction has concentrated.

  Strengths

  They are still up about 110% year-to-date, indicating strong prior fundamental and thematic momentum.

  Weaknesses

  They have declined about 12% from the June peak and are sensitive to Momentum and AI crowding.

  Comparison

  Compared with Software, Semiconductors remain meaningfully stronger on a year-to-date basis, but the current pressure is more visible.

  Risks

  High expectations, elevated valuation, and positioning crowding make them more sensitive to earnings disappointment.

• Software

  One of the sectors with weak or negative correlation to Momentum.

  Strengths

  It has rebounded about 5% since the Momentum peak and has benefited in the rotation in the short term.

  Weaknesses

  It is still down about 23% year-to-date, suggesting fundamentals or market preference have not fully recovered.

  Comparison

  It has shown near-term opposite performance to Semiconductors, but remains behind on a year-to-date basis.

  Risks

  If capital-intensive and AI hardware-linked groups regain earnings confirmation, Software’s relative rebound may struggle to sustain.

• Capital Intensive basket GSSTCAPI vs. Capital Light basket GSSTCAPL

  Core thematic trade under the HALO framework.

  Strengths

  It benefits from strong demand, low supply elasticity, pricing power, and earnings visibility, and is up about 20% year-to-date.

  Weaknesses

  Correlation with Momentum has increased after strong performance, making it more exposed to systemic de-risking and factor volatility in the short term.

  Comparison

  It has been stronger relative to the Capital Light basket, but the recent pullback suggests growing crowding.

  Risks

  If capex expectations cool or earnings fail to deliver, the theme could shift from a tactical pullback into a deeper adjustment.

• Aerospace & Defence

  Industry that outperformed implied returns from Momentum beta.

  Strengths

  Supported by robust earnings momentum, NATO 3.0-related commitments, geopolitical tensions, and support from German and UK governments.

  Weaknesses

  Could be affected by policy pace, budget execution, and valuation.

  Comparison

  Actual performance is stronger than what the factor model implied, validating the constructive view in the report.

  Risks

  Geopolitical easing, budget delays, or earnings below expectations could weaken performance.

• Healthcare

  Defensive and valuation-supportive sector.

  Strengths

  The report says Healthcare has shown resilience, supported by attractive valuation and defensive characteristics.

  Weaknesses

  Earnings growth expectations are relatively weaker than in some cyclical or technology sectors.

  Comparison

  It has been relatively stable during the Momentum pullback.

  Risks

  If the market shifts back toward high-beta growth and capex beneficiaries, its defensive profile may cap relative performance.

• Telecoms

  Goldman Sachs still maintains Overweight, but it is a sector performing worse than its implied beta recently.

  Strengths

  The report explicitly states it remains Overweight.

  Weaknesses

  Its post-peak performance is below the return implied by its Momentum beta.

  Comparison

  In comparison with Aerospace & Defence’s excess performance, Telecoms have lagged in the short term.

  Risks

  Insufficient earnings delivery or continued market preference for other defensive/policy-supported sectors.

• Consumer Discretionary

  One of the Underweight directions mentioned in the report.

  Strengths

  Could benefit if consumer expectations improve.

  Weaknesses

  The report says it has underperformed and remains Underweight.

  Comparison

  It has not shown sufficient relative resilience in this rotation.

  Risks

  Consumer demand, interest rates, and earnings revisions could continue to pressure the sector.

Key data

• Momentum performance since June 22约-8%The report says this is one of the sharpest Momentum reversals in recent years.
• European Semiconductors performance since June peak约-12%Despite the pullback, they are still up about 110% year-to-date.
• Software performance over the same period约+5%It rebounded in this period but is still down about 23% year-to-date.
• YTD performance: Capital Intensive vs. Capital Light约+20%This corresponds to the HALO-related trade of GSSTCAPI versus GSSTCAPL.
• Europe Q2 consensus EPS year-on-year growth11%The report describes the expectation as high; earnings delivery is the key.
• Europe EPS growth excluding Commodity Producers约6%This indicates that a sizable share of aggregate growth is contributed by Commodity Producers.
• STOXX 600 2026E EPS growth15.3%The table shows 2026E STOXX 600 EPS growth; 2027E is 10.1%.
• Technology 2026E/2027E EPS growth20.9% / 24.7%The table shows Technology still has relatively high earnings growth expectations.
• Europe STOXX 600 NTM P/E14.7xThe valuation table shows it at a 70% historical percentile.
• STOXX Europe 600 sales exposureEurope 42%, North America 24%, Asia-Pacific 19%, Emerging Markets 15%Index sales exposure indicates European equities are not purely a domestic-revenue asset.

Impact & implications

For investors, the main implication is not to treat the sharp Momentum decline as evidence of broken fundamentals. If Q2 earnings continue to deliver, AI investment cycle exposure, capital-intensive beneficiaries, and some defensively or policy-supported sectors may remain attractive. But because HALO’s correlation with Momentum has risen sharply, short-term portfolios need to manage volatility from factor crowding, valuation, and systemic de-risking.

Risks

• If Q2 earnings fail to meet elevated expectations, the pullback may transition from a technical positioning adjustment to a more persistent style rotation.
• Momentum, HALO, and AI-related winner trades are crowded; rising correlation can amplify systemic de-risking.
• European index valuations are at a relatively high historical percentile, so valuation pressure may rise if earnings are not delivered.
• AI-related winners such as Semiconductors had very large short-term gains, making them vulnerable to profit-taking and expectation downgrades.
• Market liquidity thins in summer, which can amplify short-term volatility in factors and thematic baskets.
• Geopolitical developments, government spending commitments, interest rates, and FX changes may affect Aerospace & Defence, capital-intensive industries, and cross-region revenue exposure.

What to watch

• Whether European companies can deliver about 11% YoY EPS growth during the Q2 earnings season.
• Whether the roughly 6% EPS growth excluding Commodity Producers can spread across a broader set of sectors.
• Post-peak guidance and order visibility for European Semiconductors since the June pullback.
• Whether HALO-Momentum correlation continues to rise or cools off as the pullback progresses.
• Whether Aerospace & Defence continues to outperform its Momentum beta-implied return.
• Whether Telecoms can improve relative performance under an Overweight view.
• Whether European flows, volatility, skew, dispersion, and industry correlations indicate easing systemic risk.