Investor interest in European stocks is rising, driven by increased defence and infrastructure spending, hopes for a Russia-Ukraine resolution and post-war reconstruction.
“At the start of the year, we saw Europe as an optional opportunity, but it is now becoming a reality,” says Pictet’s chief investment officer César Pérez. “One of the best things to happen to Europe was Trump’s election — it forced European leaders to take action.”
Markets are already pricing in stronger growth, driven by investment and a potential rebound in consumer confidence. Peace in Ukraine could accelerate this recovery, lifting sentiment and benefiting certain sectors. “It’s crucial to be selective with European stocks, favouring those linked to domestic consumption while maintaining exposure to cyclicals. European defence looks more attractive than US defence. The focus should be on banks and luxury goods, while avoiding oil and certain multinationals,” he says.
Tariffs will be sector-specific, impacting autos, healthcare, agricultural and defence. “Other parts of the economy won’t be affected that much.”
While European equities have outperformed their US counterparts this year, they remain fairly valued rather than overpriced, says Bernd Meyer, chief investment strategist at Berenberg Wealth and Asset Management.
Fund flows indicate growing interest in European markets. The sentiment-driven rally in Europe could gain further momentum if structural reforms — such as Germany’s new fiscal stimulus package — are successfully implemented, he says. “If Europe can transition from a sentiment-driven rebound to a fundamentally positive growth story, European equities should continue outperforming,” he adds.
Mr Meyer expects lower equity returns than 2024 but sees greater upside in European and emerging market stocks. “We do not expect a repeat of last year’s 20 per cent gains in the US. With no room for valuation expansion, US equity returns are likely to be capped at 5-8 per cent, driven solely by earnings growth.”
However, Tracie McMillion, head of global asset allocation strategy at Wells Fargo Investment Institute, cautions that optimism in European stocks may already be priced in. She also highlights the risk of a potential blanket 25 per cent US tariff on European goods, which could dampen momentum.
Long term prospects
Nearly half of CIOs in this year’s PWM Global Asset Tracker survey consider European equities attractive or very attractive.
Europe has underperformed the US since the 2008 financial crisis, held back by falling real incomes, declining wealth, and demographic challenges, says Beat Wittmann, CEO and founder of Porta Advisors in Switzerland. He sees investment opportunities in sectors undergoing transformation rather than waiting for a full recovery. Defence remains his top investment theme, underpinned by rising military spending and policy shifts benefiting companies such as Airbus, BAE Systems and Thales. He also sees potential in banking, where industry consolidation and the push for a European banking union could drive growth. The European Central Bank, he says, has little choice but to approve the UniCredit-Commerzbank merger, warning that failure to do so would signal deeper structural problems.
Another key challenge is Europe’s fragmented capital markets, prompting companies to seek IPOs in the US, where valuations and liquidity are stronger. A unified European capital market, he argues, would improve investment conditions and strengthen the euro’s role as a reserve currency.
Despite slow progress, Mr Wittmann remains optimistic about Europe’s long-term prospects, with Germany’s historic fiscal stimulus emerging as a key growth driver. He stresses the need for higher defence spending and, beyond traditional military hardware, he highlights growing opportunities in cyber defence, space technology and artificial intelligence. “We must implement the Draghi report and strengthen Europe’s strategic autonomy. That means increasing defence spending to at least 3-4 per cent of GDP, consolidating our defence industry, and cutting unnecessary regulation and red tape. Above all, we need long-term investment to drive sustainable growth.”
A more integrated capital market, combined with common bond issuance, could provide the funding needed for defence and the energy transition. “Europe moves two steps forward, one step back — but change is happening. Now it’s time for action.”
Big picture trends
Once a background concern, politics has become a driving force in investment strategy. “Politics now play a larger role in investment decisions, requiring investors to pivot quickly,” says Pictet’s Mr Perez. He increasingly consults with emerging market investors, whose experience in managing geopolitical risk is now just as relevant in developed markets.
Markets today are noisy, but real news demands quick action. “Small dips? I ignore them. Major shifts, like German policy changes? You act fast — markets don’t wait. Acting pre-emptively, as we did with rates and European allocation, is even better.”
Berenberg’s Mr Meyer echoes this sentiment: “Trump generates daily headlines, making it tempting to react to every development. Instead, we focus on bigger-picture trends, such as the weakening dollar.”
David Storm, CIO of RBC Wealth Management Europe, expects 2025 to be “a trader’s market”, where success depends on seizing opportunities amid shifting conditions. He sees the new US administration exporting volatility and high rates, much like in 2016-2020, and argues that policy-driven uncertainty is fuelling global market turbulence.
Markets are increasingly vulnerable to extreme narrative swings, with 2024’s rate moves offering a prime example. “These over-extended shifts create opportunities,” he says. The approach is to “dynamically manage exposures, diversify across return drivers, and focus on companies set to benefit from policy changes”.