Global equities: The case for Europe

A funny thing has happened thus far in 2025.

No, we’re not talking about tariffs, nor trade wars. Those aren’t very funny, at least not for investors.

Rather, the interesting thing is that—after years of underperformance—European stocks are ruling the 2025 global equity roost. And, in our view, that’s a position they are unlikely to soon relinquish.

In what follows, we outline why we think solid European equity market performance remains probable and what styles and sectors we believe will likely best boost portfolio returns. We conclude with risks to the view.

Why Europe?

Investors can be forgiven if they are skeptical. After all, over the past 15 years the broad European market (STOXX Europe 600 Index) has underperformed its US counterpart (S&P 500 Index) by a whopping 296% in local currency terms and by over 300% in dollar terms.[1]

Ouch!

So, it takes either a brave person or a fool to suggest that now may be different.

Well, perhaps things are different.

After all, over the first four and a half months of 2025, European shares are up 8.5%, handily ahead of the paltry 1.1% for the S&P 500.[2]

And a closer look at the fundamentals, valuations, and other factors suggests to us that Europe’s surge in absolute and relative terms is not a fluke.

In terms of macroeconomics, Europe enjoys several forward-looking cyclical advantages.

First, having delivered lower inflation last year, the European Central Bank (ECB) has been able to continue monetary policy easing in 2025—unlike the US Federal Reserve. As a result, the main policy rate in Europe is now 2.25%, a full two percentage points lower than in the United States. Borrowers in Europe now enjoy a zero real (inflation-adjusted) interest rate, also roughly two percentage points lower than in the United States.

In short, monetary policy settings are now significantly easier in Europe than in the United States.

Second, the combination of Russia’s threat to European sovereignty and US global security ambivalence has swung European fiscal policy into action. This year’s German elections captured a mood shift evident across Europe in favor of increased borrowing and spending to meet Europe’s military, energy, and national security concerns. According to the International Monetary Fund (IMF), the change in Germany’s structural budget balance over the next two years will amount to a fiscal impulse worth 1.6% of gross domestic product (GDP), and in France of 0.8%. The corresponding IMF estimate for the US is fiscal drag equivalent to -1.4% of GDP.[3]

Simply put, cyclical policy support—monetary and fiscal—now appears to favor an acceleration of European GDP growth relative to the United States over the next 18 months.

And where economic growth goes, corporate earnings typically follow. After a miserable 2024, during which European earnings (MSCI basis) fell, analysts are now more upbeat, with forecasts calling for double-digit earnings growth for this year and next.[4] Meanwhile, S&P 500 earnings estimates for 2025 are dipping, with figures compiled by FactSet indicating 9.0% full year earnings growth, slightly below European profit forecasts.[5]

Valuations also favor Europe. A comparison of one-year forward price-to-earnings (P/E) ratios shows the S&P 500 trading on a multiple of 20.2 times, compared to just 14.2 times for the STOXX Europe 600 Index.[6]

Two other factors may further tip the scales in Europe’s favor.

First, European equities offer income opportunity, both via a higher dividend yield (3.2% versus 1.4%) and greater percentage of dividend yielding stocks (93% versus 75%) than found in the US equity market.[7] If global growth slows later this year, income opportunities may move to the fore for many equity investors.

Finally, there is the “X-factor.” For investors growing nervous about erratic US domestic and international politics and policies, European equities may offer a form of diversification from idiosyncratic US political risk. That is a novel idea, but one that may carry weight, particularly as investors have at times this year suffered simultaneous drawdowns in US stocks, bonds and the dollar.

How to play it

In our recently published survey of Franklin Templeton investment managers, the results showed a clear preference for large capitalization, growth and value styles. Among our professionals, favored sectors are information technology, health care, and consumer staples.

Within the European markets, several of those themes also resonate. Much of Europe’s fiscal impulse will be directed at defense and security spending, which in terms of modern warfare means smart weapons and national security systems solutions offered by technology firms. Europe is also likely to continue to heavily invest in energy infrastructure, including storage and transmission. And, as noted, companies with strong and sustainable dividends, including those within consumer staples, are likely to be sought after. Finally, to the extent euro strength (US dollar weakness) prevails, which could impair the earnings of larger capitalization European stocks via negative foreign earnings translation effects, financials offer avenues to participate in underlying European growth and profits recovery story.

Risks to our view

Europe’s outperformance is not assured. As seen in March/April, spikes in uncertainty depress share prices globally. Hence a renewed outbreak of trade conflicts or geopolitical turmoil poses clear risks to the view.

All equity markets could also be at risk from a further sharp rise in global government bond yields. European fiscal expansion, an inability of the United States to rein in large budget deficits, and the highest rate of Japanese inflation in a generation are putting upward pressure on long-term interest rates worldwide.

Finally, European earnings are dependent on global factors, meaning that pronounced dollar weakness (i.e., euro strength) would negatively impact European corporate profits via weaker translation of foreign earnings and diminished export competitiveness, with only partial offset coming via lower import costs.

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WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal.

Equity securities are subject to price fluctuation and possible loss of principal.

Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer or guarantor, may affect the bond’s value.

International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Diversification does not guarantee a profit or protect against a loss. Dividends may fluctuate and are not guaranteed, and a company may reduce or eliminate its dividend at any time.

WF: 5420966

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[1] Source: Bloomberg.

[2] Source: Bloomberg. As of May 20, 2025.

[3] Source: “Fiscal Policy Under Uncertainty.” IMF Fiscal Monitor. April 2025. There is no assurance that any estimate, forecast or projection will be realized. There is no assurance that any estimate, forecast or projection will be realized.

[4] Sources: FactSet, MSCI, FactSet Estimates. There is no assurance that any estimate, forecast or projection will be realized.

[5] Source: FactSet Earnings Insight. May 16, 2025.

[6] Sources: FactSet, S&P Dow Jones Indices, Stoxx.

[7] Sources: FactSet, MSCI. Analysis by FT Institute.