Time flies: already, two months of the 2025 stock market year have gone by. A look at performance to date should leave one or two investors rubbing their eyes in disbelief, for European equities are the measure of all things. The broad-based STOXX Europe 600 Index is trading at a good tenth above its closing level in 2024. Over the same period the S&P 500 Index has climbed by just 1.2%. In the first few weeks of 2025, then, the old continent has delivered its strongest outperformance relative to Wall Street for a decade. Europe also has its nose in front when compared with the weakening Japanese market and emerging market equities (see graph). This lightning start is all the more astonishing given that just a few weeks ago the outlook for the continent was considered anything but rosy.
At the heart of concerns was Germany, with Europe's largest economy suffering from an almost chronic lack of growth. Its gross domestic product has shrunk over both of the last two years, and the German government’s Council of Experts anticipates growth of only 0.4% for the current year. While this body reckons the eurozone will see expansion of 1.3%, that means the forecast for the currency union remains about half that of the world as a whole. The discrepancies highlight the enormous challenges facing the next German government. Nevertheless, the Bundestag elections have strengthened hopes of political reform and economic stimulus. The Chancellor-designate, Friedrich Merz, of the CDU/CSU is considered to be business-friendly. Although the first priority for the CDU politician and election winner is to negotiate a coalition agreement with the SPD, he is receiving early plaudits on the stock markets. Alongside domestic German matters, geopolitics is also making headlines on capital markets. There may have been a spectacular falling-out between US president Donald Trump and Ukrainian president Volodymyr Zelensky, but at least an end to the Ukraine war is being talked about again. On top of this is the fact that while Trump is talking up a trade conflict with Europe, the feared escalation has not happened yet.
In addition to the brighter environment, valuations also point towards an investment in the old continent, with European equities sometimes showing marked discounts on a global comparison. At the end of January the price-earnings ratio (forward) for the MSCI Europe Index stood at 14.0, but the key ratio for the US benchmark, also calculated by MSCI at the same time, came in at more than half as much again, and Wall Street’s price-to-book ratio is actually more than double the European level. Europe’s companies traditionally score with high dividend yields – distributions from the equities contained in the MSCI Europe are currently equivalent to an interest rate of over 3%. It goes without saying that the valuation discount also has something to do with the fact that the US stock exchange has hugely outpaced European marketplaces in recent years (see table).
The “granolas” have played a key part in the latest race to catch up. This is the term given to a group of European companies which lead their respective sector. They represent a sort of alternative to the “magnificent 7”, a top Wall Street selection. The granolas delivered convincing figures in the latest reporting season. Take SAP, for example: Europe’s largest software group exceeded analysts’ expectations with its results and also offered a strong outlook. While the SAP share then continued its record chase, Nestlé is making an impressive comeback: the market capitalisation of the food giant has increased by 16% since the turn of the year. Investors seem to be trusting the new CEO to manage the transition. Laurent Freixe would like to accelerate Nestlé’s growth through higher advertising and marketing expenditure, among other measures. Although it is also stepping up its cost-cutting efforts, the industry giant is once again increasing its dividend somewhat. This balancing act is made possible by a strong balance sheet and high cash flows – in 2024 Nestlé recorded a free cash inflow of CHFbn 10.7. Ultimately, such qualities, which are typical of the granolas, suggest that the lightning start enjoyed by the European equity market into 2025 was not a flash in the pan.
Source: Reuters; as at: 28 February 2025. Past performance is not a reliable indicator of future performance.
Source: MSCI (Index Fact Sheets); as at: 31 January 2025