Europe’s Stoxx 600 Index reached a record high last week and has outperformed the S&P 500 Index year-to-date (yes, we know it’s only January). After one of the worst years of performance relative to the US in 2024, are European equities back in favour? Is the rally justified and sustainable, or is this yet another false European dawn?
Since we’re not given to hype, let’s just say: European equities once again have an important role to play in investors’ portfolios.
Recent years of US exceptionalism have been entirely justified, driven by the disproportionate value creation in US stocks. However, this has come at a cost: heightened valuations on both an absolute and historical basis, and a significant divergence from other regions of the world.
This is most pronounced in Europe, where relative valuations sit near the 99th percentile versus historical levels. While justified by years of economic and structural challenges, these depressed valuations are beginning to attract attention.
Figure 1. US exceptionalism versus European sclerosis
European discount is at an all-time high versus the US
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Profitable company, low valuation – what’s not to like?
Europe’s valuation discount reflects years of underperformance as investors looked elsewhere for growth. The region didn’t present an attractive picture: weak economic growth, political uncertainty, and dominated by a manufacturing base slow to adapt to the digital age.
Despite this seemingly negative backdrop, we are starting to see evidence that European equities can once again help investors to diversify away from highly concentrated holdings, both geographically and across sectors.
Indices once dominated by oil majors, miners, and manufacturers are now home to a new generation of global leaders in technology, healthcare, and luxury goods. These companies combine strong pricing power, global leadership, and, above all else, profitability.
Last year was marked by missed expectations—while some of Europe’s new generation of leaders delivered impressive growth, many fell short of the market’s high targets. This disconnect between share price performance and fundamentals has left high-quality names trading at attractive valuations. At the broader market level, earnings growth revisions have stabilised and Q4 results have got off to a good start —an encouraging development that has largely gone unnoticed.
Catalysts for change
Furthermore, there are a number of (geo)political and macroeconomic catalysts that could support this re-rating, even if the challenges facing the region remain significant.
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Political stabilisation: Europe’s two largest economies, Germany and France, have faced notable political uncertainty in recent years. In Germany, the dissolution of the coalition government in late 2024 has set the stage for snap elections next month, raising hopes of more effective fiscal policy and increased government spending. In France, the new government has survived its first no-confidence vote and received EU support for slower deficit reduction. While neither situation is resolved, even modest progress could improve sentiment and unlock growth.
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Supportive monetary policy: With a subdued economic growth outlook, European Central Bank (ECB) policymakers have hinted at a less hawkish stance. Talk of further rate cuts has dragged the euro lower, versus the US dollar in particular, providing a significant tailwind for the region’s export-driven industries. Lower for longer rates are likely to be supportive for risk assets as we move through 2025.
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China’s recovery: Concerns about China’s economic slowdown weighed heavily on Europe last year, given the region’s reliance on exports to the country. Any improvement in Chinese consumption could provide a meaningful boost to European leaders in technology, luxury goods, and industrials, offering an additional boost to earnings growth.
A case for diversification
Europe’s equity markets today look very different to a decade ago, offering exposure to a mix of innovative, global companies with the potential for alpha driven by the wide valuation dispersions in the market. While the challenges facing Europe are far from resolved, the asymmetry of the opportunity is compelling. With sentiment still near historic lows, even incremental improvements – whether political, fiscal, or company-specific – could drive a meaningful re-rating of the region.
All data Bloomberg unless otherwise stated.
With contributions from Nick Wilcox, Managing Director, Discretionary Equities, and Chris Litchfield, Associate, Investment Services, Man Group.
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