Talk of European exceptionalism is misguided. But with the transatlantic relationship unsettled, as well as fiscal, policy, and regulatory easing, it’s a timely moment to ask: is the continent entering a new era?
We have been here before. Rumblings of the end of US exceptionalism, unbridled enthusiasm for European stocks for some, schadenfreude for others when the rally proves short-lived.
We won’t fall into the trap of saying that this time is different with regards to Europe’s pronounced outperformance of the US – and indeed many other equity markets – so far in 2025. Markets are volatile and perhaps the early portion was a combination of short-covering and fast-twitch momentum money. But where we are happy to nail our colours to the mast is that the requirement for something different is objectively here. There are a variety of differing opinions as to whether the Trump administration really does mean the end of the transatlantic relationship as it has stood since the end of WWII, and given the speed of newsflow this year, forecasting seems futile. Even so, it is becoming clearer by the day that Europe must take steps to secure independence across many domains.
This brings us to Germany. The news that the German parliament approved a tweak to the constitution and broke with decades of fiscal orthodoxy by injecting EUR500 billion into infrastructure spending, and theoretically unleashing unlimited spending on defence, should not be dismissed as anything except momentous. Perhaps not because of the scale of the spending (although it is significant in European terms) but because of what it signifies: fundamental changes are underway on the continent, the effects of which are likely to ripple far and wide.
Does this mean we are moving into a period of European exceptionalism? This seems unlikely, and indeed it is a moniker many would rather not be saddled with, given the inferences as to what that would mean for much of the West. When the US enters recession territory, the rest of the world rarely escapes unmarked. But there are reasons to be hopeful that this may bring about a long overdue recognition that European equities have been unduly overshadowed, even with the headwinds that the bloc has faced in recent years.
Due to the often-dominating narrative of US equity market exceptionalism, investors may have missed the fact that equities elsewhere in the world have performed strongly across multiple time horizons in absolute terms.
Take Europe, for example: over 5, 10, and 15 years, European equities have returned 11%, 6.2%, and 8.3% per annum, respectively – hardly numbers to be sniffed at. Similarly, Japan has returned 13.7%, 8.7%, and 10.8%1 pa over the same timescales. But with the trifecta of better earnings growth, higher GDP growth, and higher productivity, US markets have overshadowed this. Encouragingly though, all three of these elements are being reclaimed outside of the US.
Fiscal and defence shifts
As a direct result of the policy initiatives being undertaken by the Trump administration, Europe is undergoing a significant shift in fiscal policy, unseen in this century. As the need to re-arm the continent progresses, and the tectonic plates of geopolitics re-align, so the levers of power are being shifted to increase spending in areas of the economy that are inherently more productive, with the sectors most likely to suffer being social rather than industrial. Having seen two years of economic decline and next to no growth, the incoming German government’s move to release spending restraints is likely to transform not just its own economy, but that of Europe as a whole. With debt-to-GDP of only 60%, compared with 120% in the US2, Germany’s prudence over the last few decades has positioned it to almost single-handedly push European economic growth higher.
If Germany’s low growth would normally suggest poor GDP data across Europe given its relative size in the bloc, last year proved the opposite. Periphery countries such as Ireland, Spain, and Portugal, all recorded real GDP growth above 2% in 20243, which only compounds the positive momentum that would occur if economic powerhouses such as Germany and France were to see a significant economic pickup stemming from productive investment.
If the adage that Europe is forged in crisis is demonstrably shown by the reaction to the euro-crisis and the Covid-19 pandemic, so the recent moves by the EU mirror this concept. Regardless of whether Europe can adopt the mantle of the economic and political behemoth that it so often fails to exploit, there is clearly a central recognition of the need to reassess the often-burdensome fiscal rectitude of the bloc. This is demonstrated by the EU Commission’s exemption of defence spending from fiscal rules as well as the establishment of a EUR150 billion EU loan facility to fund military expenditure. This is compounded by the acknowledgement by bureaucrats that while stable policy (especially in a time where US policy is tantamount to the antithesis of this) is all well and good, dogma with regard to regulation has been damaging. Policymakers may just be waking up to the fact that competitiveness operates on a global scale, not just on the continent.
In conjunction with the interest rate cutting cycle of the European Central Bank remaining ahead of the Federal Reserve, which is already spurring an uptick in the Eurozone bank lending cycle – an important indicator given how integral bank lending remains in Europe – the economic signs for the bloc are improving rapidly. Earnings revisions are positive, with a sharp acceleration from the last two years of decline. High-single digit EPS growth appears achievable, even with the potential impact of any tariffs. Although headline figures appear concerning regarding tariffs, diving into the detail demonstrates that the impact to earnings should be relatively subdued given the manufacturing undertaken on US soil, the industries likely to be exempt such as defence and biotech, and especially as the sectors with most exposure have already seen their prices decline.
Broader valuations remain very supportive for the region even after the recent rally, and total shareholder returns are compelling. As historically has been the case, the dividend yield in Europe has far outshone that of US stocks, although this has often been offset by buybacks in the latter. Conversely the last 12 months have now seen a higher level of buybacks in Europe, and a combined net buyback and dividend yield of 6.4% versus 2.8% for the US.
A false dawn?
Critics may say that there have been false dawns before regarding Europe, and that US equity markets are currently operating from an unassailable position with regards to size and liquidity. We would not dispute the scale advantages of the US. Instead, we would re-emphasise that international equity markets should exist as a component of an equity allocation not just due to the current market conditions, but because these markets are made up of some extremely high-quality businesses that have existed, in many instances, for hundreds of years and continue to generate good returns for investors.
Europe is undoubtedly undergoing a significant shift at the moment as it transitions towards fiscal expansion, regulatory unburdening, and financial cohesion. But this change should be viewed as complementary to the longer-term trend of great global businesses with diversified revenue streams, broad-based markets where returns have not been concentrated into a small number of holdings, and a differentiated sectoral composition that in a shifting environment can offer diversified sources of return.
