The case for European equities

Fundamentals, valuations paint a positive picture

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 U.S. 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 U.S. 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 U.S. 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 U.S. 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 U.S. 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 U.S. domestic and international politics and policies, European equities may offer a form of diversification from idiosyncratic U.S. 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 (U.S. 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.

On May 23, President Trump announced that trade negotiations with the European Union (EU) are “going nowhere” and that he is considering a 50% tariff on EU imports commencing on June 1. In response, global equity markets and bond yields have dipped, led lower by European equity indexes, which are down today by 1%-2%.

Nevertheless, we retain our view that European equities are poised to outperform this year. European earnings growth remains underpinned by synchronous monetary and fiscal easing, which will lift domestic demand and earnings for information technology and defense industries, as well as for financials. Moreover, akin to “reciprocal” tariffs, Trump’s statements are apt to be a negotiating tactic. Tariff levels for EU goods will probably settle near global norms of 10%, and for autos at 25%.

Consequently, we are not changing our constructive view on European equity markets because of today’s pronouncements.

Stephen Dover, CFA, is Franklin Templeton’s Chief Market Strategist and Head of the Franklin Templeton Investment Institute. Originally published in Stephen Dover’s LinkedIn Newsletter, May 22, 2025. Follow Stephen Dover on LinkedIn where he posts his thoughts and comments as well as his Global Market Perspectives newsletter.

Notes

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.

Disclaimer

What are the risks? All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Investing in the natural resources sector involves special risks, including increased susceptibility to adverse economic and regulatory developments affecting the sector. Special risks are associated with investing in foreign securities, including risks associated with political and economic developments, trading practices, availability of information, limited markets and currency exchange rate fluctuations and policies. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments.

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