The European stock market has been outperforming the MSCI AC World since the start of 2025. Despite the solid fundamentals of the US economy, rising uncertainty triggered by the Trump administration is increasing the attractiveness of European stocks.
With a strong increase YTD (Euro STOXX 50 +9%, S&P 500 -5%, MSCI Asia Pacific +2%), the European stock market has shown itself to be very robust this year compared to other international markets. The background to this development is twofold:
1. the prospect of rising investment activity in infrastructure and defence in combination with an increased focus on low European valuations since the turn of the year and
2. the recent sharp increase in uncertainty in the US with regard to potential negative economic spillover effects from the capricious policies of the Trump administration and signs of an incipient economic slowdown.
In particular, the unpredictable tariff policy is likely to affect the investment behaviour of US companies. In an environment of increased uncertainty, equity investors are turning away from highly valued sectors and companies and increasingly preferring areas that are cheaper. This is affecting the highly valued US technology companies, in particular, which make up a large proportion of the US stock market, whereas the European stock market is benefitting from its high share of value stocks.
What stands out is the valuation discount of almost 40% that European companies offer compared to their US peers. This is calculated according to price/earnings (P/E) ratios. At the same time, the risk premium for European equities is around 4.5%, which is comparatively attractive globally, particularly given that it is close to zero in the US. While earnings growth in Europe is likely to be relatively broadly based in 2025, several sectors may be poised to deliver above-average results, particularly if the strong increase in fiscal spending that is projected for Europe comes into fruition. Cyclical stocks in the industrial and defence sectors will be at the forefront to benefit from any increase in demand and therefore any increases in profit growth.
In 2023 and 2024, stock-market performance was mainly driven by technology stocks, not only in the US but also in Europe, where share prices of well-known representatives, such as SAP, have increased by 170% since 2023. The US stock market strongly benefitted from the underlying narrative of strong earnings growth in the technology sector, primarily represented by the so-called Magnificent Seven companies, which make up 30% of the S&P 500. However, this story has changed since late last year, and large US AI stocks were particularly affected by the release of DeepSeek’s free AI chatbot app on 10 January (for more details, see The Compass Checkpoint, 27 February, page 12). Profit-taking and a slower growth outlook for technology stocks led to some reallocation from the US stock market to the European stock market, which was largely underweighted in international portfolios.
This has led to an extremely rare situation in which the US stock market has significantly depreciated from the all-time highs it had reached by the end of 2024, while the European stock market, as well as the MSCI World ex-USA, has achieved new all-time highs recently. The STOXX Europe 600 has outperformed the MSCI AC World by 8pp since the start of the year. We view these trends as positive as they indicate a broadening of the global stock-market development and a reduction of the concentration risk in the US. However, as long as the US economy has a solid foundation, it is unlikely that the significant underperformance of the US stock market since the beginning of the year will continue to this extent. The greatest uncertainty regarding the European stock market remains the threat of import tariffs from the US and an escalating trade conflict.
