2025 is proving to be good year for European indices but investing in Europe is now more nuanced than simply buying an index tracker, says Darius McDermott, managing director of FundCalibre.
It’s a timely reminder of my age when a fund manager recently told me that there is a generation of investors out there who have been taught to shun European equities.
They’ve only known an era where the US, aided by aggressive fiscal stimulus, saw economic growth recover quickly in the wake of the Global Financial Crisis and technology companies then burst onto the scene to guide the market to record highs. By contrast, Europe took the conservative approach, by repairing large deficits on balance sheets through austerity and increasing regulation around banks’ capital requirements. Growth became a secondary requirement, resulting in a benign period for the region.
Between 2008 and 2024 US equities have comfortably outperformed the region to the tune of more than 500% (S&P 500 704.8% vs. 178.3% STOXX Europe 600)*. But 2025 has seen a role reversal, with Europe outperforming (17% vs. 3%)**. Much has been made of this being down to the challenges facing the US economy – with investors subsequently looking to diversify their portfolios as a result. Slowing growth and a softening labour market amidst rising tariff uncertainty have played a major role, as has the fall of the US dollar. We’ve all seen the headlines about the end of US exceptionalism.
A research note from Lightman, which runs the WS Lightman European fund, says while it appears US markets have brushed off the volatility seen earlier in 2025, currency movements actually shroud the fact that Europe’s outperformance versus the US is the largest first-half relative return since 1973***.
Their data on US household allocations to US equities also shows this could be a good time for investors to continue cutting their exposure to the world’s largest economy. Effectively the data, which goes back almost 75 years indicates that the higher the allocation, the lower the forward returns. Equities as a percentage of bank deposits have averaged 154% since 1952. The all-time low reading was June 1982 at 40%, the all-time high was March 2000 at 298%. We currently sit at 277%. For clarity, the 40% figure in 1982 is widely regarded as the best entry point for equities in the last century***.
Europe’s performance is much more than the US faltering
If we are seeing that shift away from US equities, there are plenty of reasons to suggest Europe is an attractive and sustainable alternative. Europe’s outlook is improving due to falling inflation and strong reforms. We’re seeing energy costs dropping, margins boosted and investment. The eurozone’s trade surplus and improving debt dynamics contrast with US fiscal challenges – increasing the attraction.
Baillie Gifford European equities investment specialist Thomas Hodges says the region has started to recognise the need to change. He cites increased defence spending and a change in position from the region’s “austerity champion” Germany as examples. This includes the infrastructure spending package worth €500bn over 10 years, which, when combined with defence spending, represents around 20% of Germany’s GDP****.
He says: “This U-turn marks a sea change in fiscal philosophy for a country once allergic to deficits. It is now making the case to fellow EU members that the fiscal rules, which have for so long hamstrung investment, should be relaxed, creating the potential for a much larger wave of fiscal expansion. Philosophical shifts aside, this is particularly interesting because the US appears to be turning inward and retrenching, making it almost the opposite of its response to the GFC.”
At 14.1x price-to-earnings, Europe’s valuation discount to the S&P 500 (21.9X) is still very attractive, despite the recovery we have seen this year****. Moreover, we have seen around $400bn flow out of European equity strategies in the past decade alone. European domestic investors have significantly increased their allocation to US assets over the past 15 years, rising from 15% in 2009 to more than 40% in 2025 (this compares to around 32% in their home market)^.
A bottom-up approach from here?
Goldman Sachs Research forecasts the STOXX Europe 600 will rise about 5% over the next 12 months and anticipates a 12-month total return including dividends of 8%^.
Geopolitics will cloud that view. There is ongoing uncertainty around US trade policies and the potentially negative impacts from tariffs on corporate margins and the continent’s economic growth. German exports to the US have fallen and we have also seen profit warnings from European companies off the back of a 15% rise of the euro against the dollar. But the raft of tailwinds suggest the region could handle those tariffs and still flourish from this point.
IFSL Marlborough European Special Situations fund manager David Walton says the noise of shifting sentiment should be ignored in favour of individual companies. He believes investors should concentrate on identifying businesses that are capable of prospering amid all the noise. European companies with a domestic focus are well placed to tick this box at present, since their lack of involvement in export markets should make them relatively “Trump-proof”.
He cites the likes of Greek consumer manufacturer Sarantis as an example – it has a strong presence across Europe, faces little competition from overseas and has virtually no dealings with the US.
He says: “It makes no sense whatsoever to infer that Europe in its entirety is on the rise or on the slide – or even somewhere between the two – at any one time or in light of any given occurrence. A bottom-up approach to stock selection reveals quite the opposite. In reality, there are invariably attractive opportunities out there.”
Despite a strong rally at the start of 2025 Europe still looks attractively valued and has plenty of scope to run. Yes there are geopolitical overhangs but even in the challenging periods post the GFC we saw plenty of successful European businesses (both domestic and global) flourish, making it an attractive hunting ground for active managers.
Those wanting to invest may want to consider the Comgest Growth Europe ex-UK fund, which is a high conviction fund investing in high-quality, long-term growth European companies, or the Liontrust European Dynamic fund, which has 30-40 holdings. By contrast, those looking for income might look to the BlackRock Continental European Income fund.
*Source: FE Analytics, total returns in pounds sterling, 1 January 2008 to 1 January 2024
**Source: FE Analytics, total returns in pounds sterling, 1 January 2025 to 9 September 2025
***Source: Lightman, July 2025
****Source: Baillie Gifford, August 2025
^Source: Goldman Sachs, 3 September 2025
^^Source: Marlborough Fund Managers
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.
Main image: christian-lue-7dEyTJ7-8os-unsplash
