After five consecutive months of gains, European stocks face a stress test! Can ASML-led semiconductor equipment and HALO themes break the "September curse"?

According to Zhitong Finance APP, the European stock market has entered a sensitive new phase of "still strong fundamentals, weakening tactical outlook," led by robust gains from semiconductor equipment giant ASML and a “HALO effect” that has driven five consecutive months of monthly gains. The Stoxx Europe 600 Index is up 10% this year, with its forward P/E ratio rising to 15x, higher than the ten-year average of 14.5x. Meanwhile, typical seasonal weakness in September, ongoing war in Iran pushing up refined oil and natural gas prices, expectations of European Central Bank rate hikes, political uncertainty in France and the United States, as well as the resumption of trading volumes after summer holidays, may collectively amplify market volatility.

Analysts say that the Stoxx Europe 600 Index’s support near 640 points shows that its medium-term uptrend is not yet broken, but as bullish news has gradually been priced in by market capital, the rally is shifting from broad gains to a high-volatility stock-picking phase dominated by profit-taking, asset quality, and position structure.

The past five months of gains in European equities have not been a simple macro-beta rally. Leaders in semiconductor equipment such as ASML and advanced hybrid bonding packaging equipment maker BE Semiconductor enjoyed a super dividend from global AI capex in the first half of the year. The “HALO effect”—Heavy Assets, Low Obsolescence—has continued to drive capital flows toward semiconductor equipment, energy infrastructure, industrials, defense, transportation, and utilities, which are physical assets less likely to be replaced by AI. Stocks bearing the “HALO” aura, including ASML and BE Semiconductor Industries NV, have a high weighting in Europe's heavy asset markets, whereas the U.S. market is weighted more toward "lightweight capital" stocks.

Since July, as the semiconductor sector underwent a periodical correction globally, the European market, with its high entry barriers, long-term stable cash flows, and lower technology disruption risks, has become a key destination for global funds seeking to diversify away from the high concentration risk in U.S. tech stocks. Unlike the Philadelphia Semiconductor Index and Nasdaq 100, which are extremely crowded and high-beta, Europe’s market integrates the AI compute growth factor into a widely diversified, low-concentration, traditional high-quality industrial base with strong long-term cash flow.

European equities’ five-month rally faces seasonal risks, as the streak runs headlong into a “September curse”

Europe’s five-month rally will soon face a historically challenging period, just as macroeconomic risks are mounting.

September is usually the weakest month of the year for the Stoxx Europe 600 Index, which over the past five years has averaged a 2.1% decline. This time, the seasonal pattern coincides with hawkish policy signals from European central banks, rising political uncertainty in France and the U.S., and prolonged Middle Eastern geopolitical tensions centering on Iran.

As summer’s lull ends and trading volumes are expected to rise, with the Stoxx Europe 600 Index already up 10% this year, the European market’s sensitivity to negative news is likely to increase further.

Violeta Todorova, senior research analyst with one of the European asset management giants, Leverage Shares, said: "After a strong rally, the market is vulnerable to volatility shocks. Room for error on earnings and valuations has shrunk, so investors may be less willing to ignore disappointing data or negative news."

As shown above—September has a seasonal negative impact on European equities. Over the last five years, the Stoxx Europe 600 Index has averaged a 2.1% decline in September.

Daily market moves show the change may already have started. As of August 20, the Stoxx Europe 600 Index had declined for seven straight trading days, almost setting its longest losing streak in a decade. Though declines were slight, it signals sentiment has started to cool since the index set a record high earlier this month.

Hawkish central bank policy and crowded positioning could amplify volatility

For now, the overall uptrend remains intact, as the index rebounded from support near 640 points. This suggests some investors still believe that strong corporate earnings and resilient economic growth will provide long-term support.

Alpesh Patel, a partner at RootBridge Capital, notes that weekly momentum is weakening even as the monthly uptrend channel remains, “which usually means the market is digesting recent gains rather than topping out.” However, he adds, investors “have every reason to be nervous, as September often exposes a market where bullish positioning has become increasingly crowded and upside catalysts are exhausted.”

As shown above, bullish momentum in European equities is weakening; however, the overall upward trend remains. Note: The chart shows the daily candlesticks for the Stoxx Europe 600 Index.

A major risk comes from inflation and the future path of ECB monetary policy, largely because the Iran war in the Middle East is pushing energy prices higher. Large-scale AI spending is also expected to add to price pressures. Swap market traders have all but fully priced in a possible ECB rate hike next month.

Investors will get further clues at the Jackson Hole Economic Policy Symposium on Friday. Fed Chairman Kevin Walsh is scheduled to speak later today, followed by ECB Executive Board member Isabel Schnabel. Schnabel stated earlier this week that intensifying Middle East tensions are pushing inflation risks higher, and with eurozone economic performance unexpectedly strong, benchmark rates need to rise further.

Bearish signals are flashing as funds flow into European equity futures. According to strategists at Citigroup, though overall European equity positioning remains the strongest among developed markets, there was a "mild deterioration" in sentiment last week. Their data shows that recent flows have been driven mainly by new short positions in the blue-chip Euro Stoxx 50 and German DAX indices.

In a research report, Citi strategist David Chew wrote: “Key tactical risks focus on the German DAX, where profitable longs and deeply underwater shorts coexist, creating an asymmetric flow structure.” He continued: “This setup means the market faces heightened volatility risk, which could be triggered either by a short squeeze or an acceleration in profit-taking.”

AI beneficiaries heat up amid hesitation, valuation premium enters profit verification phase

Marina Zavolock, chief European equity strategist at Morgan Stanley, believes that one of the hottest trades in the European market may also be showing signs of fragility. A basket of large stocks benefiting from AI application expansion is up 13% this year, mainly as investors bet that record-level capex on the technology will drive potential cost savings and labor productivity gains.

But Zavolock notes that this run-up has been marked by caution. “Investors have been very hesitant to re-enter Europe’s AI capex beneficiaries, and there are many concerns,” she said, citing worries about the European economic and tightening cycles.

As the Stoxx Europe 600 Index looks set for a fourth straight year of gains, the overall valuation for European equities has become more expensive. According to compiled data, the benchmark index is now trading at about 15x forward earnings, slightly above its ten-year average of 14.5x.

As shown above, European stock valuations are above average—a four-year rally has pushed the P/E ratio past the ten-year average.

Barclays strategists recently warned that the U.S. midterm elections to be held in November could also spark market volatility. The team led by strategist Emmanuel Cau commented: “A slow, steady rise remains our base case, but the typical turbulence of the back-to-school season and persistently weak September mean a continued rebound may require the bond and oil markets to remain calm.”