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Why European Equities Are Outperforming Amid Low Growth and Security Concerns

European equity performance has been strong so far in 2025. While Europe still faces significant political and economic challenges, its stocks may benefit from a dovish ECB interest rate policy and an improving geopolitical outlook.

25 février 2025 Temps de lecture: 5 min

Ryan Reardon

Senior Equity ETF Strategist

Consensus expectations headed into 2025 were that US large-cap stocks would continue to outperform their global peers. But the year so far has ushered in an unexpected reversal of geographic leadership in global equities (Figure 1).

Significant challenges remain, including stagnant growth, but a sense of cautious optimism and rock-bottom valuations appear to have created an opportunity in European stocks. Looking forward, two macro factors may provide support for European equities on a valuation-relative basis. The first is expectations that the European Central Bank (ECB) may be more aggressive in reducing interest rates compared to the Federal Reserve (Fed); and the second is market anticipation of a resolution of the war in Ukraine.

Figure 1: European Stocks Lead the Way in 2025

Trailing 30-days Return (last 1 year)

Interest Rate Policy Divergence

The ECB began 2025 by moving quickly to reduce its key refinancing rate by 25 basis points (bps) to 2.9%. The Governing Council said the inflation outlook, as well as the strength of monetary policy transmission, shaped the decision. Further cuts are anticipated, with implied futures suggested the rate could drop below 2.2% by midyear, and below 2% by year end.

This significantly contrasts with the Fed's more cautious approach, as the US continues to battle stubbornly high inflation. The Fed's median projection for 2025 anticipates only a 50bps reduction in the federal funds rate, which the market anticipates will be back-loaded. Implied futures suggest the rate will be unchanged at midyear.¹

This divergence in monetary policy creates a unique opportunity for European value stocks, as lower rates ease the cost of borrowing (small caps) and help boost what have been severely depressed earnings multiples (Value). While a large part of the justification for accommodative rates in Europe is to support the slower growth, value stocks with stable earnings and strong balance sheets are likely to be the primary beneficiaries of any re-rating in European equities.

For this, we would encourage investors to consider a select approach to harvesting value stocks with a light quality overlay offered by the SPDR® MSCI Europe Value UCITS ETF (ZPRW / EVAL).

Resolution in Ukraine?

The war in Ukraine has of course impacted European markets. The timeline remains unclear but the market appears to be anticipating a potential resolution this year. Polymarket is currently reflecting a 68% chance of a ceasefire agreement in 2025 (as of 19 February 2025).²

A resolution to the conflict would remove a significant source of uncertainty and risk for European markets, paving the way for increased investment and economic activity. This would be particularly beneficial for European value stocks, which have been disproportionately affected by the conflict due to their exposure to sensitive cyclical sectors.

Figure 2: Index Fundamentals (Last 1 Year)

Figure 3 – Sector Breakdown of Selected European Small-Cap and Value indexes

GICS Sector Exposure

Breakdown of selected European small-cap and Value indexes by sector

As 2025 began, markets were caught off guard by the positive relative move in European equities. Significant challenges to European growth remain but there appears to be a support in the short term for European equities on the basis of accommodative policy and improving geopolitical conditions.

We encourage investors to consider the opportunity to play this theme by allocating to high-quality value stocks, domestically focused small caps, or small caps with attractive valuations. Looking at the fundamentals of European equities (Figure 2) and evaluating the unique sector exposure offered by each strategy (Figure 3) may help you identify which strategy is the best potential fit for your portfolio.

Footnotes

Disclosure

Marketing communication

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7641877.2.1.EMEA.INST

Expiration Date: 28/02/2026

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