During the course of 4Q24, European 12M forward earnings estimates started to improve, while they softened slightly in the US after increasing by 13% in 2024, as Chart 2 shows. This was largely driven by expectations of gradually increasing growth in Europe, while growth rates in the US are expected to slow slightly.
US tech-sector earnings, which were largely responsible for the stock-market rally of the last 12 months, have been failing to fully meet high expectations.
In recent days, conditions for further and sustained acceleration in European earnings forecasts have continued to improve, as significant increases in government spending on infrastructure projects and defence in Europe are expected in the coming years (see also The Short View – Germany’s fiscal “bazooka”, 5 March). Against this background, we think our previous estimates of an increase in 12M forward earnings estimates of almost 10% for STOXX Europe 600 companies this year is likely to be too conservative. We expect earnings growth estimates for European companies to catch up, on average, with those of US companies in the quarters ahead. However, investors should take this with a pinch of salt, as neither the planned government spending on infrastructure and defence in Germany nor a defence budget at the European level have yet been finally decided.
New plans for additional infrastructure and defence spending in Germany and the EU are likely to substantially support economic-growth expectations. Growth momentum in Europe is highly likely to increase from a very low level, while such momentum in the US is set to decrease from a higher level. Stock markets traditionally react strongly to changes in relative momentum. This has already been true over the last few months and is likely to continue if fiscal spending plans are implemented in Europe. A major unknown and potential burden on the European economy and the stock market is US tariff and trade policy. This puts a question mark over the further development of the European stock market in the coming months. However, with the support of large government spending in the coming years and the associated support of economic demand, the European stock market has a solid foundation to become more attractive to international investors in the longer term.
Over the last ten years, the European stock market has faced a strong decline in relative P/E-ratio valuation versus the US. This was largely based on a stronger economic and company-earnings dynamic in the US compared to Europe. Meanwhile, the European stock market was trading with a huge P/E-ratio-valuation discount to the US of almost 40%. While this is not a timing indicator, it illustrates the attractive valuation level of Europe in relative terms. In absolute terms, the S&P 500 has a P/E ratio based on 12M earnings estimates of 21.5 and the STOXX Europe 600 of 14.2, while earnings growth is improving in Europe and slightly softening in the US, as we explained above.
Another important point is that European equities offer a much better risk premium than US equities. The equity-risk premium compares the earnings yield (inverse P/E ratio) with a risk-free rate (i.e. government-bond yield). In other words, the equity risk premium is the excess return that investing in the stock market provides over a risk-free rate. This excess return compensates investors for taking on the relatively higher risk associated with equity investing. As Chart 5 shows, the equity risk premium in the US is close to zero, while it is 4.5% in Europe. This puts European equities in an attractive position, and this could be further strengthened by any improvement in relative economic sentiment.
In conclusion, we think the European stock market offers good opportunities for diversification. The fundamental underlying factors for the European stock market have strengthened since the start of the year. This has recently been further reinforced by the significant planned expansion of fiscal spending in Europe. Industrial stocks, in particular, are likely to benefit from this, but banks are also likely to receive support from higher interest rates (higher interest income) due to higher government spending than was expected at the end of last year. Although this has yet to be proven, it could not only support economic growth but also partially mitigate the effects of possible US tariffs. With regard to the US, we continue to see economic growth as above potential and expect the US stock market to stabilise around current levels in the short term and to regain momentum later this year (our 2025 target for the S&P 500 is 6300 index points, +12%).
