European Markets Are Becoming Increasingly Difficult to Ignore

HerbertBusiness2025-06-302090

(Bloomberg) -- European stocks outperformed their US peers by the biggest margin on record in dollar terms during the first half, the most dramatic sign of how the region’s markets are staging a comeback after more than a decade in the doldrums.

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The rebound isn’t confined to stocks: the euro is up 13% against the dollar in the six months through June. Meanwhile, the chaotic rollout of US tariffs wiped some of the shine off Treasuries. German bunds have outperformed them since April even as the government braces to issue more debt. Assets in emerging European markets like Poland and Hungary are also rallying sharply.

Investors globally are slowing their purchases of US assets and shifting more money to Europe amid concern that President Donald Trump’s program of tariffs and tax cuts will impact earnings, stoke inflation and widen the budget deficit. Europe has become the big beneficiary as governments there boost spending while its central bank slashes interest rates.

“We’re seeing extremely strong demand for European assets, particularly from the US,” said Erik Koenig, who runs the EMEA equity sales desk at Bank of America Corp. in London. “While Europe has faced challenges in the past that may have held its markets back, there’s now a growing confidence in its long-term potential.”

For Koenig, the shifts in the US have prompted Europe to take steps that have suddenly — and sustainably — improved its outlook.

The region has had false dawns before, and the political instability and cumbersome regulations that deterred investors for years haven’t fully gone away — valuations in Europe remain depressed relative to the US.

But something profound has happened, particularly after Germany removed its debt brake. Europe’s biggest economy is now committed to borrow more and invest massively in defense and infrastructure after more than a decade of austerity, igniting a new sense of optimism.

“It’s an exciting time to be in European markets,” Koenig said.

At the European Central Bank, officials have been cutting rates aggressively, in contrast to the measured approach from the Federal Reserve. The rate differential will remain at or close to two percentage this year, based on swap market pricing.

The wave of government spending, which will be funded through fresh debt sales, is expected to deliver a much-needed growth boost to the euro area. For Allianz Global Investors, one of Europe’s largest asset managers, this has been a clear signal to slow its buying spree in US assets, and return to stocks and bonds at home.

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“We don’t feel comfortable in Treasuries anymore. We are going to the bund market,” said Greg Hirt, chief investment officer of multi-asset strategies at the firm. “There will be more issuance in bunds because of German fiscal policy, but that is good because it makes it a more liquid market.”

At the same time, the euro stands to benefit from the economic growth boost after underperforming for the past decade. The currency was headed for its longest stretch of monthly gains in eight years, and JPMorgan Chase & Co. is among firms that see it reaching $1.20 this year, up from $1.04 at the end of 2024.

Mark Nash at Jupiter Asset Management is even more bullish on regional growth. “It wouldn’t surprise me if we hit $1.30 within around six to eight months,” he said, adding that he sees the common currency surging to $1.40 next year, a near 20% jump from current levels.

Meanwhile, low rates and stimulus measures will support corporate earnings, with both the US and Europe estimated to provide 10% to 11% profit growth next year. European stocks trade at a 35% discount to their US peers, making for attractive valuations. European firms pay higher dividends, too, while buyback yields have become comparable.

“While profit growth in Europe may not be as strong as in the US, the valuation gap remains very big,” said Peter Oppenheimer, chief global equity strategist at Goldman Sachs Group Inc. “Dividends and buybacks will increase, making the region attractive in total returns.”

Even as US stocks have started to catch up with global peers in June, powered by a renewed appetite for the artificial intelligence trade and reduced tariff fears, something seems to have changed in the way Europe is perceived by asset allocators.

A net 34% of investors are currently overweight euro-area equities, compared with a net 36% underweight US peers, according to the Bank of America fund manager survey published this month. On top of that, over half of asset managers expect international shares to be the top asset class over the next five years, while only 23% picked the US.

There’s also been a drastic change in allocation. European-focused equity funds have attracted $46 billion of fresh money since the start of 2025, on track for the second-largest annual inflows ever, according to BofA citing EPFR Global data. That’s a sharp contrast to last year, when there were $66 billion of outflows.

In the fixed income space, over $42 billion has flowed into European-domiciled funds tracking bonds issued in the common currency, compared to just $5.6 billion for those focused on dollar-dominated notes, also marking a flip from the trend in 2024. Even US companies are borrowing in euros like never before.

And there could be a lot further to go especially for equities after investors, especially foreign ones, piled into the US for years. UBS Group AG analysts expect €1.2 trillion ($1.4 trillion) of capital to rotate from US to European equities in the next five years. They see international ownership of the US equity market retreating to 27% over that period from 30% currently.

“American exceptionalism is touching its limits,” wrote Natixis cross-asset strategists Emilie Tetard and Florent Pochon, adding that both foreign and domestic investors have piled into US equities in recent years.

They expect a normalization in these inflows, citing a declining dollar, rising political risks, AI competition and a narrowing economic growth gap versus the rest of the developed economies. “US investors are to diversify their exposure to international equities, while non-US investors are to reallocate their equity investments toward domestic equity markets.”

To be sure, things might start looking up for the US in the second half. The Fed is expected to start reducing rates by September, which will help bolster the case for Treasuries. Meanwhile, there’s renewed appetite for technology stocks as the AI theme continues to prove supportive for earnings.

The US market is dominated by a club of tech companies worth more than $2.5 trillion like Apple Inc. and Nvidia Corp., seen as key beneficiaries of AI. The European market doesn’t have any real AI plays and there’s not a single public company valued at over $400 billion. The sheer size of the US alone, comprising 70% of the MSCI World Index, means it still automatically gets the bulk of passive inflows.

Even so, the growth prospects due to the changes in European governments’ fiscal policies are enough to keep the bulls optimistic. That’s especially true as the region is a beneficiary of investors reallocating their holdings amid US policy uncertainty.

“Diversification will continue to play out,” Goldman’s Oppenheimer said. “Europe will be quite a compelling story for investors.”

--With assistance from Julien Ponthus, Jan-Patrick Barnert, Sagarika Jaisinghani, Abhinav Ramnarayan, John Viljoen and Anthony Palazzo.