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Europe has seemingly confounded equity investors for many years. And the opacity has arguably ramped up recently. For example, does more defense spending, a new German government placing emphasis on fiscal stimulus, a possible ceasefire and peace deal between Ukraine and Russia, and the need for greater independence amid tariff uncertainty justify a re-rating of the European equity market?

Before trying to answer such a question, it is worth remembering that the economy is not the stock market, and that the price you pay for an investment really matters.

Since 2000, nominal US Gross Domestic Product (GDP) has grown at approximately 4.5% per annum vs. Euro Area GDP growth of 3.4% per annum.¹ On a more granular level, per capita real disposable income has grown almost twice as much in the US as in the EU over this period. How should we explain this? We could start with the structural and cyclical components but in practice, like a soup, there are multiple ingredients that combine in many ways.

Structurally, key factors include one market region vs. ‘one’ market of 27 countries, with implications across all sectors and industries (from both an operational and capital investment perspective). These factors have made Europe a less dynamic place to do business.² This can be observed, for example, in the relative absence of a technology sector in Europe and a geographically fragmented banking sector.

Of course, economies have borne the wounds of the global financial crisis and taken the necessary medicine, too. However, the US medicine of banking recapitalization and ultra loose monetary policy proved an effective treatment – GDP recovered to pre-crisis level in just over three years compared to at least six years for the Eurozone.

Sometimes it is the aggregation rather than the individual components that act as a catalyst for change.

In the case of Europe, it is the confluence of geopolitics – the invasion of Ukraine and the change in US trade policy. It may also be the belated recognition – as highlighted by Mario Draghi in his The Future of European Competitiveness report – that “Europe’s need for growth is rising.” Framed by Draghi as being the most open in trade terms and the most dependent with the highest energy prices, Europe lags on technology and defense investment and the report is a call to action to close the innovation gap.

What could start the ball rolling? In March 2025, the incoming German government announced fiscal spending plans equivalent to around 20% of annual German GDP, split between defense and infrastructure, financed by a proforma increase in net debt/GDP to around 80%.³ Although the other major European countries do not possess the same balance sheet strength as Germany, the ripples of fiscal loosening will likely spread beyond Germany and into other markets and sectors.

Trade wars are likely to disrupt long-standing trade flows. The current global tariff arrangements have been largely unchanged for 20 years. This led to increased globalization of trade, a move to lower cost and a regularity of trade flows. This regularity has been called into question by recent tariff announcements. We expect this to create opportunities for both reshoring of local business and new export markets.

Will these catalysts be sufficient? The future is uncertain, but based on the evidence, we believe these developments should lead to structural improvement in the European growth outlook.

Although a region’s stock market is not the same as its economy, it does act as a form of proxy. Like the economy, the European stock market has seriously lagged over multiple time periods.

Figure 1 : MSCI Europe vs. S&P 500 total return over the past 20 years

Amid shifting policy dynamics and tech concentration in the US, we think there are good reasons for these correlations to persist and remain lower than the historical average in coming years. This means adjusting an SAA with increased geographical diversification lowers overall portfolio volatility, thereby improving risk-adjusted returns. Indeed, even if US stocks were to moderately outperform European stocks over coming years, risk-adjusted returns may still be higher in portfolios that tilt more to Europe, due to greater regional equity diversification.

The dramatic difference between Europe and US stocks over the past 20 years has led to a very wide valuation gap (shown below) between the two regional stock markets.

Figure 2: Europe vs US average valuation discount

Looking at long-term history, there are plausible justifications for European stocks to have traded (on average) at a sizeable discount to US stocks – a gap which had continued to widen until the start of 2025.

Some of the key reasons include sector composition variance, along with differences in cost of capital, accounting conventions, incentive structures and regulation. This is before you consider the relative ease of doing business, with the US operating as a single market in a pure sense, while Europe acts as ‘one market’ but consists of 27 countries and over 200 languages.

Technology growth is another obvious anomaly. The fascinating question for investors is how does the difference across the two regions impact the level of long-term premium for US stocks?

Figure 3: Sector composition Europe vs. US

Using some simple math, we estimate that approximately 25% of the historical premium over the past 10 years can be explained by the higher exposure to technology in the US vs. Europe. However, if we compare the current discount with the long-term discount, tech cannot explain it all.

To reach an appropriate valuation is, as always, a combination of art and math.

But the current discount is too large in our view. Given the catalysts outlined above, we believe now could be an opportunity for a revaluation of European equities.

Further, this valuation discount should be considered alongside the attractive dividend yield available on average for European stocks – i.e., getting paid income while waiting for the capital valuation discount to reduce.

Not all industries or stocks are created equal. While investors can seek broad market exposure (a valid approach) to benefit from European recovery, we believe this could also lead to missed opportunities and allocation of capital to expensive areas of the market.

Adopting an analytical view of the fundamentals and adding valuation discipline can be a powerful combination for investors. For example, the sectors that, under a particular scenario, have the most visceral appeal, may actually turn out to be poor investments if the price valuation is unattractive. The current wide valuation spreads found across and within European stock market sectors as well as the polarization between growth and value category valuations are cases in point. Indeed, European value-based approaches endured headwinds following the global financial crisis that still leave valuations depressed today.

Next, we dive deeper into different sectors or industries where the combination of attractive fundamentals and interesting valuations hold our attention.

We view the banking sector as the circulatory system of any economy – the arteries and veins and the health of the banking sector is critical to sustained growth. In Europe, the recovery from the global financial crisis has been much slower than in the US as tighter regulation, low interest rates and weaker loan growth combined to hold back share price returns.

15 years on, these returns have recovered to higher levels than US peers (see Figure 4). Banks should also be a key beneficiary of fiscal expansion in Europe with attractive gearing to help achieve better growth through expansion in loan books.

Figure 4: European banks are outperforming US peers

Europe is home to eight of the top 20 pharmaceutical companies globally on a revenue basis. The industry has demonstrable strengths, including in the development of treatments for cancer and the production of generic drugs.

The sector has lagged other defensive sectors due to weaker pricing power during recent high inflation periods, which has led to below average relative valuations. However, we believe that technology-led R&D investments combined with global demographics such as aging populations make healthcare an attractive industry on a long-term basis.

When you think about luxury brands, several iconic names immediately come to mind,

known for their distinctive logos and high-quality products and they will almost all share a common geography – Europe.

These companies have faced a perfect storm of weak export demand at a time of channel overstocking and cost pressures, yet we view many of these companies as having an enduring franchise value. These headwinds have left major companies in the sector trading at depressed valuations.

Value investors often see the benefit in being selectively contrarian. While industrials may appear to be an obvious way to pursue the European recovery, we would tread carefully as valuations imply the need for a more nuanced approach. For example, the largest global capital goods companies are trading on high valuations relative to other sub-sectors like transport equipment providers.

The European industrials sector is particularly heterogenous, spanning airlines to machinery to professional services sub-sectors. Consistent with this variety, there is a large range of company valuations requiring a selective investment approach which provides an interesting universe for stock pickers to select from.

It is clear that the European economy and stock market have been running at half speed. However,

there is evidence that Europe is switching gears

and this in turn may generate alpha opportunities.

As active managers though, a one-size-fits-all approach to the Europe renaissance may not be optimal. Instead, by applying a selectively contrarian, valuation-sensitive investment approach, Europe’s alpha opportunities may not be quite so elusive after all.

¹ Macrobond, 2000-2024.
² The Future of European Competitiveness, European Commission. 2024.
^3��German spending plans raise hopes for an economic lift, �۶���Ƶ Wealth Management, March 6, 2025