Strategists at JPMorgan on Monday downgraded European capital goods and chemical sectors, two sectors closely geared to an economic recovery, and took a more favorable stance on more defensive, dividend-paying telecoms and consumer staples.
The recommendation stands at odds with the recent investor enthusiasm on European stocks which has largely hinged on the recovery in profits and the upswing in the region's economy.
Europe is enjoying its brightest set of quarterly corporate earnings since 2010, with banks, industrials and capital goods companies posting strong results that have, on average, exceeded expectations and stoked a rush back from investors.
European stocks are up nearly 10 percent this year and are outpacing other developed markets.
But valuations for some sectors are getting stretched, JPMorgan strategists led by Mislav Matejka, wrote in a note to clients, noting European capital goods and chemicals stocks in particular.
"..everybody has turned bullish on earnings now, and the bar for Q2 and 2H has been raised materially. Earnings could, in fact, soften over the next few months," they added, noting weakness in recent data from the U.S. and China.
Capital goods stocks were trading at the richest price-to-earnings multiples relative to the broader market since the peaks seen in 2007 and 2011, JPMorgan wrote, adding they had now overshot levels backed up by economic data.
The case for European stocks was bolstered by Emmanuel Macron's weekend win in France's presidential election against far-right candidate Marine Le Pen, which removed one of the biggest political risks for the bloc this year.
The return of inflows into the Eurozone will likely continue to support the market in the very short term, JPMorgan said, but recommended investors use any further gains to lock in some profits and pare back positions in stocks.
"We believe that once the inflows are spent, one should look to reduce directional exposure to equities," the strategists wrote.