Following years of underperformance when compared to the US, there is finally some optimism for European equities

Up until recently, the US equity market seemed unstoppable. Fuelled by supportive policy and a highly competitive marketplace, it outpaced its global counterparts year in and year out. But suddenly that has changed. Fears over tariff policy, growth and inflation have put a halt to the US market’s outperformance, allowing European companies to perform against a backdrop of relative valuation advantages, fiscal stimulus and resilient earnings growth.

In the first quarter of 2025, European large-cap equities went up by 10.4%, outpacing their US peers, which fell 2.9% over the same period, according to Bloomberg data. This resurgence has been driven by a combination of favourable factors that could narrow the longer-term performance gap with the US.

Relative valuations

European markets have historically traded at a discount to their US counterparts – and, more recently, this gap has widened significantly. The Euro Stoxx 50 index, which measures the 50 largest eurozone companies, has a forward price-to-earnings (P/E) ratio of just under 15x expected earnings, according to Bloomberg – a significant discount to the S&P 500’s 21x.

This is because the European market has less concentration in mega-cap technology companies and more exposure to traditional industries such as financials, industrials and materials. Historically weaker growth prospects in Europe are another reason.

Nevertheless, there are reasons to believe the tide may be turning. The deep discount of European equities provides a cushion against downside risks and room for re-rating if economic conditions do improve. This, along with fading US exceptionalism, are encouraging a rotation of capital into European markets in 2025.

Fiscal stimulus and earnings growth

Fiscal stimulus, particularly from Germany, is emerging as a key catalyst for European equities. After decades of strict fiscal discipline, Germany’s new government is shifting toward expansionary policies in an attempt to boost the stagnant economy.

It is proposing a €500bn (£426bn) infrastructure investment fund and similar defence spending exceeding both the spend on Reunification and the World War II Marshall Plan in relative percentage of GDP. The stimulus is expected to boost euro area GDP growth by an estimated 0.5% to 1% in 2025, benefitting the entire region.

The European Central Bank has also adopted a more accommodative stance, cutting interest rates multiple times since mid-2024, with further reductions anticipated through mid-2025. Lower borrowing costs, combined with fiscal loosening, could stimulate economic activity and bolster equity markets.

A return to earnings growth is also supporting European equities. After a long period of stagnation, consensus estimates for European earnings growth are between 8% and 10% over the next 12 months, narrowing the gap with the US’s expected range of 12% to 14%. Sectors where Europe has significant exposure, such as financials, industrials and cyclicals, are poised to benefit from an improving economic backdrop.

Tariff risks

On the flipside, the biggest risk to Europe’s resurgence comes from the US. The Trump administration’s imposition of tariffs on its trading partners has reverberated around the globe.

Europe is particularly sensitive to tariffs targeting the automobile sector, which is a major contributor to the European Union’s GDP. While the potential for any negotiated exemptions could provide a positive catalyst, there remains a high degree of uncertainty surrounding the ultimate scope and impact of the tariff measures.

Potential catalysts

A number of positive catalysts serve to mark European equities out as an attractive investment. Their undervaluation relative to the US offers a compelling entry point, while fiscal stimulus could re-ignite economic activity.

With a projected increase in earnings growth, European stocks are well-positioned for potential near-term outperformance. Despite risks such as tariffs and geopolitical uncertainty, Europe appears ready to finally step out of the US’s shadow, offering investors a diversified and attractively priced alternative in global equity markets.

Style-neutral stockpicking

Zadig Asset Management’s style-neutral philosophy and active approach to stock selection is well suited to the evolving geo-political environment. The iMGP Euro Select Fund, managed by Zadig, follows a disciplined and research-intensive approach.

When selecting companies, the investment team seeks to exploit what they call the ‘comfort bias’ that they believe the market has, and do not shy away from anti-consensual or controversial ideas as long as the risk/reward on valuation is attractive.