Could recent European equity outperformance continue?

There are many reasons to be positive on the prospects for European equities in 2025 in our view. The most immediate positive catalyst for performance would be for the European Central Bank to focus less on inflation and move decisively to support growth. Cutting the deposit rate to 1.5% or below from the current 2.5% could help revive confidence across the European economy. Another boost could come from the relaxation of Germany’s debt brake following the recent election, or via material policy stimulus in China (noting that Asia Pacific accounts for a very significant 20% of revenues within the STOXX Europe 600 index). An end to the war in Ukraine on terms that are deemed acceptable would remove one of the darkest clouds that has hung over the European market over the past three years, particularly if it led to lower energy prices. Progress in implementing Mario Draghi’s recent recommendations on how to boost the European Union’s competitiveness could also provide a welcome boost.

A strong start to 2025

Improving sentiment combined with positive earnings revisions has created the best start to a year for European equities relative to US equities since 2000 - the MSCI Europe has outperformed the S&P 500 index by over 10% year-to-date (in USD terms). Despite this strong outperformance from European equities in the last few months, relative valuations between the two regions remain extreme in a historical context, with European equities trading at a -35% price-to-earnings discount to their US counterparts.

The case for growth stocks

Nowhere is this valuation discount more acute than in Europe’s premier growth stocks. These stocks are characterised as offering higher rates of earnings growth than the market average, and in many cases enjoy enviably strong competitive positions in their respective industries, enabling them to generate market-leading returns on their invested capital. The MSCI Europe Growth Index* has not traded at a cheaper price-to-earnings multiple relative to the S&P 500 index for at least six years – the last time Europe’s growth stocks traded at a level this low relative to US equities was 2018. And yet based on consensus earnings estimates, European growth stocks are expected to deliver an identical level of earnings growth in 2025 to the S&P 500 (16%).

Characteristics of quality growth stocks

(1) They need to be robust to competition and generate high and sustainable returns on capital.

(2) They need to have attractive long-term growth prospects.

(3) Most critically, they need to be managed by excellent stewards of corporate capital, who can maintain both returns and growth through time.

Near-term risks

The current environment has seen rising government bond yields in Europe on the expectations of fiscal expansion, with an emphasis on defence and infrastructure spending. This presents a near-term performance headwind for Europe’s growth stocks. Any economic uncertainty created by US trade tariffs directed towards the region could also act to put downward pressure on European equities. The European market will no doubt present obstacles to navigate in 2025, but we may still see positive catalysts.

* The MSCI Europe Growth Index captures large and mid-cap securities exhibiting overall growth style characteristics across the 15 Developed Markets countries in Europe. The growth investment style characteristics for index construction are defined using five variables: long-term forward EPS growth rate, short-term forward EPS growth rate, current internal growth rate and long-term historical EPS growth trend and long-term historical sales per share growth trend.

Earnings growth refers to forecast EPS growth excluding exceptional items for calendar year 2025.

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