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News headlines this week have been dominated by recession fears in the U.S., with the S&P 500 and the Magnificent 7 shedding value. Yet, amid this rising uncertainty, a positive story is emerging—the performance of European markets.
For years, European equities have been viewed as slow-moving and overshadowed by the U.S., but current performance tells a more positive story. Since the start of the year European equities have outperformed the U.S. market, with the MSCI European Monetary Union index up +8.6% YTD vs a -5% decline in the S&P 500.
Europe’s markets are demonstrating resilience, with a variety of factors contributing to the improved outlook, albeit with a few significant headwinds:
European tailwinds
Germany's fiscal shift: Post-election changes in Germany have led to optimism in what has been a stagnant European economy in recent years. German government efforts to bypass the debt brake and establish a €500 billion infrastructure plan, could help contribute to growth and create investment opportunities in the region.
Favorable policy environment: The European Central Bank has been the most aggressive globally at rate easing, with a corresponding surge in bank lending. The chart below illustrates how bank lending to households and non-financial businesses has trended upwards since late 2023, which is a positive indicator for business growth.
Defense spending: Plans to increase defense budgets, potentially funded by joint bonds, could strengthen European economic cohesion and create investment opportunities.
Falling inflation: Core inflation in Europe is now largely in line with that of the U.S. While European gas prices remain ~3x higher than U.S. prices, they have come down since 2022. Price decreases could be further supported by a potential ceasefire in Ukraine.
European headwinds
However, despite reasons for optimism, there are significant headwinds that could undermine Europe’s growth story:
U.S. trade war: U.S. tariffs could cut European GDP by ~0.5%, which is significant given the low 1% GDP growth consensus. European exports to the U.S. represent only around 3% of the Eurozone's GDP, but the overall exposure to global trade is much larger. With Europe reliant on exports, any significant tariff-related disruptions, both European-specific or globally, could have a meaningful economic impact.
Fiscal deficits: While countries such as Germany have increased fiscal space, this is not the case for all European countries. For instance, France’s high deficit (~6% of GDP) limits its fiscal flexibility, creating potential risks for broader European stability.
The bottom line
There’s reason to be cautiously optimistic in Europe. We’ll need to see how the trade war plays out, but the uptick in bank lending in Europe is a positive sign. After a tough decade, Europe is showing signs of resilience and renewed optimism. The big question now is whether this can last.
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