European stock markets have been on a tear this year, brushing off tariff threats, political volatility and economic stagnation — and strategists see significant upside ahead, even if a long-awaited annual outperformance over their U.S. peers remains elusive.
In January, the pan-European Stoxx 600 index notched its best outperformance against the S&P 500 for that month in the past decade, rising by 6.3% versus 2.7%. That momentum has continued into February, with the Stoxx 600’s 3.3% monthly gain as of Feb. 18 coming in well above the S&P 500’s 1.25%.
This bullishness around Europe may appear surprising on some levels. U.S. President Donald Trump’s return to the White House has been described as fueling U.S. business optimism, while the euro area’s biggest economies — Germany and France — are both mired with political instabilities. U.S. economic growth also remains well ahead of the U.K. and euro zone’s.
And it would not be the first year that European markets have kicked off the year strongly before stumbling behind the U.S. on an annual basis (excluding 2022 when its losses were shallower, the Stoxx 600 has not delivered a better performance than the S&P 500 for a decade).
However, the U.S. is now grappling with tariff-related inflation concerns, while central bankers in Europe have largely downplayed the risk of a knock-on impact on prices in their own countries. The Bank of England, European Central Bank and Swiss National Bank are all expected to keep cutting interest rates early this year, while the Federal Reserve treads water.
“The market is getting a little bit more concerned about stagflation in the U.S. … that policy uncertainty in the U.S. is perhaps one of the reasons why there’s been quite a lot of demand to diversify away from the U.S.,” Gerry Fowler, head of European equity strategy at UBS, told CNBC’s “Street Signs Europe” last week.
Fowler noted that the U.S. accounts for more than 70% of global equity market capitalization, meaning it doesn’t require a lot of money to move from the U.S. elsewhere to have a “fairly big” impact.
“That’s what we’ve seen in Europe. We’ve seen hedge funds in particular buying,” he added.
But Fowler and others have also identified a range of factors supporting Europe, leading UBS to upgrade Europe relative to the U.S. “We believe Europe can outperform U.S., near term,” UBS Investment Bank said in a note.
‘Enjoy it while it lasts’
Positive earnings revisions have also been one of the drivers of European equity strength this year, Citi strategists said in a note Tuesday.
European revision trends look “more impressive than in the U.S.” while “upwards revisions have been meaningfully stronger than seasonal patterns would predict,” they wrote.
When this has happened to the same level before, European earnings have outpaced the U.S. by around 5% on average over the next six months, the bank said, and the MSCI Europe ex-UK Index has kept pace with U.S. equities over the same period.
“The latest [Earnings Revisions Indices] readings, if they continue, could be a lead on actual [earnings per share] being upgraded, while providing a potential tailwind for further European equity market gain,” the strategists added.
Citi’s global equity strategist, David Groman, told CNBC last month that the bank was still overweight on the U.S. in its global allocation, but that Europe was its “favorite diversifier in the cyclical, rest of world space.
“One of the reasons for that is we are maybe moving past what was peak bearishness on Europe,” he continued.
UBS’s Gerry Fowler said that if Europe does continue to outperform, it won’t just be driven by European upside but also by U.S. vulnerability, particularly regarding the Magnificent 7 stocks.
These seven U.S. tech giants accounted for over half of the S&P 500’s gain in 2024, but many have come under pressure this year. Automaker Tesla’s revenue missed expectations in the fourth quarter, for instance, while chip giant Nvidia has been rattled by China’s AI startup DeepSeek.
“There’s certainly plenty of momentum and enthusiasm in Europe that I don’t think has been fully backed by regional allocators with large amounts of money, that are generally neutral to underweight Europe … and typically heavily overweight or at least neutral in the U.S.,” Fowler added.
Daniel Morris, chief market strategist at BNP Paribas Asset Management, took a more downbeat view on the recent outperformance in Europe, however.
“I think at least European investors may need to enjoy it while it lasts,” he told CNBC’s “Street Signs Europe” last week.
While Europe’s fourth-quarter earnings season was a good one, positive earnings surprises have been stronger in the U.S. than in Europe, Morris said.
“So if, fundamentally, earnings are what drive equity markets, you just don’t see the same momentum. If you look at earnings revisions, again, more supportive for the U.S. If you do get tariffs, that’s better for the U.S.,” he said, adding that the recent outperformance could be because European stocks were starting from a lower base.
“If you look at the economic data that was released last week, almost all of it disappointed in Europe. So it doesn’t really feel like — even with this [recent] performance in the market — that we’re at a turning point.”
— CNBC’s Ganesh Rao contributed to this story.
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