Europe Stocks Had Been Riding High, but What’s Next?

Author: Richard McGrath

April 11, 2025

No global equity market is safe from the potential fallout of an escalating trade war between the U.S. and the world, but Europe may be worth consideration given its relative outperformance so far this year.

The European equity market has been on a roll—relatively speaking. From the beginning of the year to April 1, the MSCI Europe Index of large- and mid-cap European companies gained nearly 12%, easily outperforming the U.S. S&P 500 Index, which declined by more than 4%. That was a sharp reversal of last year, when the U.S. benchmark index marked a total return of 25% while Europe eked out a mere 2.4%. Even after the global selloff in the first week of April, MSCI Europe remains close to flat year-to-date, while the S&P 500 had lost more than 10%, officially entering correction territory.

Can Europe’s outperformance last? The easy answer to that question is that it all depends on Donald Trump. Since the re-elected U.S. President took office in January, his administration has set about reorienting long-standing alliances, including with Europe; implemented punishing tariffs on other countries, including historically reliable trading partners such as Canada, Mexico and the European Union, and attempted to broker peace between Ukraine and Russia (at what cost to Ukraine, we still don’t know). For European leaders, a key concern has been Trump’s apparent desire to weaken the transatlantic military alliance and decrease financial and military support for Ukraine. And now another concern: Trump’s imposition of 20% tariffs on imports from the European Union, as part of the President’s April announcement of “reciprocal tariffs” on more than 180 countries and territories.

Global markets have responded to Trump’s tariffs with the biggest selloff in five years. But that occurred in a context where investors had been looking beyond the United States to park their money for some time, and European equities have been among the beneficiaries. Between Feb. 14 and March 14, according to Morningstar, European investors moved nearly US$16 billion into European equity ETFs while drawing down U.S. equity ETF exposures by more than US$3 billion. That compares unfavourably (from the U.S. point of view) to 2024, when U.S. ETF equity inflows outpaced European ones by a factor of nearly nine to one. As well, European defence and aerospace stocks have rallied as investors anticipate increased European Union military spending—the MSCI Europe Aerospace and Defense Index gained 33% to the end of March. And it has not been a one-way trade: Blackrock reported that U.S. inflows to European equity ETFs were seven times larger in the first quarter than in Q1 2024.

Beyond the Trumpian turmoil, other short-term and sectoral factors have also been driving the Europe rally this year. One of them is simply a matter of “what goes up must come down”—and vice versa. U.S. stocks surged in the wake of last year’s presidential election, but the bloom has come off the market fervor both for Trump’s policies and for big-tech growth stocks. Sentiment has shifted towards value stocks, and we believe Europe suits that investing style to a tee. European equity valuations were much lower than their U.S. counterparts to begin the year, and that hasn’t changed much despite the rally: the S&P 500 price-to-earnings ratio (12-month trailing) stood at 23 at the end of March, while that of the Euro STOXX 50 index of large-cap equities was 15.5. In short, European stocks were cheap compared to their U.S. counterparts, and they still are.

The interest rate environment is also playing its part. Tariffs and Trump’s threats of meddling in monetary policy have made the U.S. Federal Reserve’s direction very unclear, and U.S. inflation has remained relatively sticky, which is keeping interest rates high. In contrast, inflation in Europe continues to fall; in Germany, for example, the March inflation rate came in at 2.3%, below economists’ expectations, according to Reuters. The European Central Bank (ECB), which has cut rates six times since last June, has been careful not to signal its next move, but continuing declines in the inflation rate have added to speculation that the ECB will trim again at its April 17 meeting.

Another possible tailwind for Europe: political stability—again, relatively speaking. The spectre of far-right governments in Germany and elsewhere largely dissipated in recent elections, and the new administration in Germany, for one, we believe seems poised to ease off the country’s long-standing debt brake to spur investment. In France, a looming budget crisis was avoided, and while the potential barring of National Front leader Marine Le Pen from running for office in the 2027 elections—the result of a court finding of embezzlement against her—may raise the political temperature this year, its longer-term consequences remain to be seen.

Currency effects have also helped European stocks. Throughout the chaos of 2025, the euro has held up fairly well. That’s perhaps largely because the first wave of U.S. tariffs was clearly directed at Canada and Mexico, leading the euro to handily outperform the Canadian dollar through March, but it also spiked against the U.S. dollar in the wake of Trump’s launch of reciprocal tariffs in the first week of April. Longer term, it is widely expected that Europe will boost domestic government spending in response to crumbling economic and military ties with the U.S., which we expect could raise the prospects for European economic growth and support the euro.

Will Trump’s imposition of new tariffs on European goods rain on the parade? To a certain extent, they surely must. But it might turn out to be more of a drizzle. As Barclays has pointed out, only 12% of European-listed company revenues derive from exports to the United States. Stocks heavily exposed to the U.S. market have already been underperforming as investors priced in the risk, suggesting that the near-term impact of the tariffs may be muted. And Trump’s tariffs may well hurt U.S. corporate earnings and economic growth, in the short term at least, which could lead to further capital flight to other regions, including Europe.

This is not to say that investors should expect smooth sailing for European equities. They are no longer as cheap as they were. Fiscal stimulus from the likes of Germany could have real economic impact only in the medium to long term. And European companies may have to navigate not just the impact of America’s realignment of its trade and defence relationships, but also continuing uncertainty over U.S. policy, for many months or years to come.

Yet despite those clear risks, there remain potential opportunities. In our view, many European stocks continue to trade at a discount to their fair value, and cyclical equities may do well if economic growth rebounds as anticipated. Investors may consider, in particular, careful exposures to European financials, materials and utilities.

So, even as the world appears to be in turmoil and the long-term effects of Trump’s geopolitical and economic agenda play out, we believe European equities may be poised to weather the storm and continue their positive performance through 2025. Relatively speaking, of course.

The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds, or investment strategies.

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