Despite the region’s improving medium to long-term prospects, European equities have repriced dramatically in recent weeks, namely in response to news of US tariffs. We believe the resulting dislocation between fundamentals and valuations marks an attractive entry point. European equity ETFs may be an efficient and cost-effective solution for broad market exposure.
At the start of 2024, many investors, who were likely underexposed to the region amid broad optimism for US stocks, had written Europe off. Today, with ‘US exceptionalism’ appearing to have peaked, investors are turning to new (or in this case, old) markets. While challenges persist, we believe a range of catalysts could favour European equities.
European valuation multiples have become attractive after a wave of indiscriminate selling earlier in April, while European Union and German stimulus packages will likely boost economic growth. A supportive European Central Bank (ECB) could provide further tailwinds, particularly for smaller companies. Below, we discuss the prospects for European equities in detail.
European stocks – Now relatively cheap
In the US, the ‘Magnificent 7’ large-cap tech stocks with strong ties to artificial intelligence (AI) or those perceived to benefit from Trump administration policies had driven the stock market higher, resulting in rich valuations before the sell-off in early April.
By contrast, Europe is still priced at an attractive discount, even though its economic prospects are now better than those of the US.
Indeed, relatively resilient data, robust corporate earnings, market expectations of lower inflation and easier monetary policy should support European stocks this year.
Downbeat investor sentiment about Europe’s outlook now appears overplayed as core inflation has been contained, and lower interest rates should boost corporate capital spending and improve consumer confidence.
Lower interest rates should benefit European equities
The ECB expects eurozone inflation to fall in the second quarter as disinflationary forces mount in the wake of the ‘Liberation Day’ tariff shock on 2 April. In addition, the effects of past energy price shocks and labour cost pressures are declining.
This should provide cover for the ECB to continue cutting interest rates, which should encourage business and consumer spending. Indeed, at 15.3%, the current household savings rate in Europe is around 3% above its average. Any reduction in the savings rate towards its historical mean could deliver a meaningful uplift to GDP growth.
Our macroeconomic team sees room for the ECB to cut policy rates further than the market is currently pricing. Lower interest rates should give a lift to capital-intensive sectors such as industrials as companies benefit from better financing conditions.
An improvement is in sight for Europe’s industry
Europe’s weak economic environment was primarily the result of weak industrial demand. The continent experienced a long industrial recession. However, sentiment has been improving in the wake of news of Germany’s stimulus measures. US tariff policy can still be a hurdle, but there are signs that Europe’s industrial recession is past its trough.
New export capacity coming onstream should push Europe’s LNG market into oversupply in the coming years, alleviating the pressure on natural gas prices and improving costs for businesses, particularly for energy-intensive industries such as chemical and fertiliser producers, steel, and tyre manufacturers.
Finally, a potential resolution to the Ukraine war would reinforce the downtrend in energy prices and the view that the industrial recession is nearing an end. A potential ceasefire between Russia and Ukraine would also lead to a reduction in risk premia for many European stocks.
Better prospects for European small caps
Improved credit conditions offer attractive prospects for European smaller companies, which have underperformed their large-cap peers.
Historically, small and mid-size stocks tend to outperform during periods of declining interest rates as they rely more on bank lending than credit markets to raise capital. So, lower rates could unlock new and better investment opportunities for these companies to enhance their long-term prospects, while lower interest expenses could boost earnings in the near term.
Looser credit conditions could also boost the rise in mergers and acquisitions benefiting the European small-cap market.
ETFs can provide efficient exposure to European equities
Having made a strong start to 2025, valuations of European equities were hit by indiscriminate selling in the wake of the announcement of a raft of US import tariffs in early April.
However, the underlying fundamentals look strong, and we remain constructive on the region’s medium to long-term prospects.
We believe the current market dislocation offers an attractive entry point, especially in European equity ETFs which can provide quick and cost-effective solutions for investors seeking broad, diversified exposure.
