Key takeaways:
- European equities have outperformed U.S. equities since the start of 2025
- Increased bank lending, easing inflation and a boost to the German economy are some of the key reasons behind this.
- The escalating trade war with the U.S. could derail some of this progress, but for now, we’re cautiously optimistic on Europe.
News headlines this week have been dominated by recession fears in the U.S., with the S&P 500 and the Magnificent 7 shedding value. Yet, amid this rising uncertainty, a positive story is emerging—the performance of European markets.
For years, European equities have been viewed as slow-moving and overshadowed by the U.S., but current performance tells a more positive story. Since the start of the year European equities have outperformed the U.S. market, with the MSCI European Monetary Union index up +8.6% YTD vs a -5% decline in the S&P 500.
Europe’s markets are demonstrating resilience, with a variety of factors contributing to the improved outlook, albeit with a few significant headwinds:
European tailwinds
Germany's fiscal shift: Post-election changes in Germany have led to optimism in what has been a stagnant European economy in recent years. German government efforts to bypass the debt brake and establish a €500 billion infrastructure plan, could help contribute to growth and create investment opportunities in the region.
Favorable policy environment: The European Central Bank has been the most aggressive globally at rate easing, with a corresponding surge in bank lending. The chart below illustrates how bank lending to households and non-financial businesses has trended upwards since late 2023, which is a positive indicator for business growth.
Defense spending: Plans to increase defense budgets, potentially funded by joint bonds, could strengthen European economic cohesion and create investment opportunities.
Falling inflation: Core inflation in Europe is now largely in line with that of the U.S. While European gas prices remain ~3x higher than U.S. prices, they have come down since 2022. Price decreases could be further supported by a potential ceasefire in Ukraine.
European headwinds
However, despite reasons for optimism, there are significant headwinds that could undermine Europe’s growth story:
U.S. trade war: U.S. tariffs could cut European GDP by ~0.5%, which is significant given the low 1% GDP growth consensus. European exports to the U.S. represent only around 3% of the Eurozone's GDP, but the overall exposure to global trade is much larger. With Europe reliant on exports, any significant tariff-related disruptions, both European-specific or globally, could have a meaningful economic impact.
Fiscal deficits: While countries such as Germany have increased fiscal space, this is not the case for all European countries. For instance, France’s high deficit (~6% of GDP) limits its fiscal flexibility, creating potential risks for broader European stability.
The bottom line
There’s reason to be cautiously optimistic in Europe. We’ll need to see how the trade war plays out, but the uptick in bank lending in Europe is a positive sign. After a tough decade, Europe is showing signs of resilience and renewed optimism. The big question now is whether this can last.
Disclosures
These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.
This material is not an offer, solicitation or recommendation to purchase any security.
Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.
Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment. The general information contained in this publication should not be acted upon without obtaining specific legal, tax and investment advice from a licensed professional.
Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.
Frank Russell Company is the owner of the Russell trademarks contained in this material and all trademark rights related to the Russell trademarks, which the members of the Russell Investments group of companies are permitted to use under license from Frank Russell Company. The members of the Russell Investments group of companies are not affiliated in any manner with Frank Russell Company or any entity operating under the "FTSE RUSSELL" brand.
The Russell logo is a trademark and service mark of Russell Investments.
This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an "as is" basis without warranty.