Is Europe gearing towards a relief rally in 2025?

Europe’s “Franco-German engine” is “kaput”, say Jon Henley and Deborah Cole in The Observer. French president Emmanuel Macron has just appointed his fourth prime minister of the year following the collapse of Michel Barnier’s short-lived administration. Across the Rhine, Olaf Scholz’s fractious coalition lost a no-confidence vote, leaving Germany heading for early elections.

“We are quite pessimistic about the economic and financial outlook for the eurozone,” says Hubert de Barochez of Capital Economics. Manufacturing remains under “intense pressure” amid tepid Chinese demand. Donald Trump’s tariff threats only add to the uncertainty – German stocks were “among the worst affected in 2018” during Trump’s first trade war. An economic turnaround requires strong government action, but in Paris and Berlin, executives are mired in dysfunction.

It’s not all bad, says The Economist. “Peripheral” countries such as Greece and Ireland were hit hard by the eurozone crisis, but following painful reforms, they are now booming. Spain is “on course to be the best-performing, rich-world economy of 2024”, with economic growth and job creation beating even the US. The local Ibex 35 share index is up 15% this year. Spain is increasingly competitive in consulting and technology. That’s a reminder that, in a modern economy, “it pays to focus on services and not fetishise manufacturing”.

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What's the outlook for Europe's economy?

The Stoxx Europe 600 index is up 7% this year, leaving European shares set to underperform the US “by the most in at least 25 years”, says Naomi Rovnick for Reuters. Yet some traders think we have reached “peak pessimism”. France’s CAC 40, down 2% this year, has not recovered from Macron’s decision to call early elections in June. Parisian fashion houses have suffered as Chinese shoppers tighten their belts. And for all the gloom about German carmakers, Frankfurt’s DAX index is up more than a fifth in 2024, says Étienne Goetz in Les Echos. This partly reflects the fact that, unlike most indexes, the DAX is a total return index (it includes dividends), but underlying performance is nevertheless robust. These days, 11% of German exports go to the US, far ahead of the 6% that go to China. Germany hasn’t totally missed out on the tech rally either, with local software giant SAP surging 73% in 2024.

Surprisingly, Germany has been “one of the best-performing stock markets in the world” since Donald Trump’s election victory, gaining more than 6% in a matter of weeks, says Katie Martin in the Financial Times. That may reflect the fact that a weakening euro will help the country’s exporters, or market bets that Germany’s next government is likely to be more effective than the outgoing Scholz administration.

More fundamentally, it is a reminder that European multinationals earn much of their revenue globally. Investors tend to overreact to “minor episodes of political instability” on the continent. Given beaten-up valuations, any “outbreak of political tranquillity in Germany and France” could set off a relief rally next year.

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