European equities enjoyed a strong start to the year, with indices like the STOXX Europe 600 and MSCI Europe delivering double-digit gains prior to US President Donald Trump’s April ‘Liberation Day’ which saw the imposition of tariffs on countries across the world.

Tariffs aside, this performance comes after a decade of relative stagnation compared to US markets, raising questions about whether Europe is finally poised for sustained growth. With favourable macroeconomic trends and sector-specific opportunities driving momentum, European equities present a solid case for investors seeking diversification into a globally important region.

Valuation and Market Performance

European equities have historically traded at a discount compared to US markets, a trend that has continued in 2025 to date. The MSCI Europe Index is valued at a forward price-to-earnings (P/E) ratio of approximately 13.7 x, significantly below the S&P 500’s 19.7 x valuation. Given the greater weighting of technology stocks in the S&P 500 as compared to the MSCI Europe, which partially explains the valuation difference, each of the 10 sectors in the MSCI Europe index have a lower P/E multiple than their S&P 500 counterpart. This valuation gap offers room for potential growth in European stock valuations.

The year-to-date performance of European equities was impressive to March, with STOXX Europe 600 posting an all-time high of 563 and gains exceeding 12%, outpacing the S&P 500’s flat performance over the same period. Subsequently, the STOXX Europe 600 and S&P 500 are both running at losses of 8% for this calendar year, after the US imposition of tariffs went from a forecasted mild scenario to a seemingly worst-case scenario. Notwithstanding this, it is expected that the apparent resurgence of the European stock market may continue, given the current low international investor positioning, improved corporate earnings, and fiscal stimulus initiatives like Germany’s €500 billion infrastructure package.

Economic Tailwinds

Europe’s macroeconomic outlook has significantly improved in 2025 as a result of:

• Inflation: Eurozone inflation stands at 2.2%, the lowest among major Western economies and near the European Central Bank’s (ECB) target of 2%.
• Interest Rates: The European Central Bank (ECB) has cut rates to 2.5%, with further reductions expected by year-end, creating a favourable environment for corporate borrowing and investment.
• GDP Growth: Vanguard forecasts European GDP growth at 1.6% in 2025, narrowing the gap with the US, which is projected to grow at 1.7%. However, the ECB offers a more cautious estimate of just 0.9% growth for the Eurozone this year.

Germany’s infrastructure spending plan may further bolster economic prospects by injecting substantial capital into domestic projects, which could ripple across the continent. These factors collectively position Europe as an attractive market amid global economic uncertainty.

Sector Opportunities

Several sectors within European equities stand out for their potential growth opportunities. These include:

• Financials: European banks are benefitting from higher interest rates and improved earnings visibility. Despite their strong performance (+26% YTD), they remain undervalued compared to US counterparts, presenting potential opportunities for value-focused investors.

• Defence: Increased military spending has propelled defence stocks like Rheinmetall AG (+121% projected growth over three months) and Thyssenkrupp (+141% in Q1), driven by geopolitical tensions and government investment in security.

• Technology: The European tech sector is rebounding after a challenging 2024, fuelled by AI-related capital expenditures and recovering semiconductor demand. This segment is projected to deliver double-digit growth in 2025.

• Pharmaceuticals: European pharmaceutical companies stand to benefit from robust drug portfolios and favourable currency dynamics as the euro stabilises against the dollar.

Risks to Consider

While the outlook for European equities is promising, several risks could impact their trajectory:

• Trade Tensions: Europe’s US$230 billion trade surplus with the US makes it vulnerable to imposition of tariffs and trade disputes.
• Geopolitical Instability: High reliance on imports for raw materials and technology creates exposure to supply chain disruptions amid global fragmentation.
• Economic Fragility: Although improving, Europe’s growth remains modest compared to other regions. The ECB’s lower GDP forecast (0.9%) highlights lingering vulnerabilities that could be exacerbated by external shocks.
• Plitical Uncertainty: Ongoing political challenges across member states could influence fiscal policies and market sentiment.

These risks underscore the importance of diversification within European portfolios and active management strategies.

Conclusion

European equities are starting to experience a revival in 2025, supported by attractive valuations, macroeconomic improvements, and sector-specific opportunities. Germany’s infrastructure spending plan and accommodative monetary policies provide additional tailwinds for growth across industries like financials, defence, technology, and pharmaceuticals.

However, investors must weigh these opportunities against their risks such as trade tensions and geopolitical instability. While European markets offer diversification benefits compared to more concentrated US markets, careful selection of companies positioned for structural growth will be key.

For those seeking exposure outside traditional US-centric portfolios, European equities may represent a compelling option—though vigilance remains essential in navigating this dynamic market environment.

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