European stocks are back in business – can it last?

European shares are enjoying their strongest start to a year since 2000 relative to US stocks, says Valerio Baselli on Morningstar. Over the past decade, capital has flowed from Europe to America in pursuit of better returns, but now the trend has reversed. European equity funds enjoyed €26 billion in net investment inflows in the first quarter, with this quarter set to be even better after global money managers were spooked by Donald Trump’s tariff drama in April. The pan-European Stoxx Europe 600 index has gained 6% this year, more than double America’s S&P 500.

A turning point came in March when German chancellor Friedrich Merz pledged to rip up the fiscal rules that have held back the continent’s largest economy since the Merkel era. The new government plans to borrow €500 billion to improve Germany’s creaking infrastructure, in addition to easing rules that have constrained defence spending. Berlin’s “astonishing reversal of fiscal policy” was greeted with elation, says John Authers on Bloomberg.

Falling interest rates are another tailwind. At 2%, borrowing costs in the euro area are already much cheaper than in the US, where they are still more than 4%, and with inflation falling below the 2% target last month, there is scope for more monetary stimulus. As the 2022 gas-price spike fades, an older truth is reasserting itself: structurally, the eurozone is less prone to inflation than the US or Britain. Banks have been surprise outperformers this year, with the iShares MSCI Europe financials index surging a third in dollar terms, says Craig Mellow in Barron’s. European banks languished during the long stagnation of the 2010s, which brought economic weakness and rock-bottom interest rates. Now they are better capitalised, while the risk posed by non-performing loans has diminished. And at roughly book value, the continent’s banks still trade at just half the level of their US peers.

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France lags behind

Europe’s rally is proving uneven. France’s CAC 40 is barely beating the US index this year, lagging far behind 17% gains in Germany and 15% in Italy. Banks represent a modest 11% of the Parisian bourse’s value, compared with 46% in Milan, leaving Italian investors to reap the rewards of the banking boom, says Corentin Chappron in Les Echos. The CAC is instead heavily exposed to the luxury industry, which is struggling as sales slow down in key Chinese and US markets. Germany has its own problems in the form of a heavy weighting towards the structurally challenged car industry, but that weak spot has been forgotten as the German government starts to spend freely, which should open the way to higher growth in Europe’s largest economy. France is having no such luck. A year after Emmanuel Macron’s snap election call resulted in a hung parliament, the country remains beset by “persistent political uncertainty”.

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Alex is an investment writer who has been contributing to MoneyWeek since 2015. He has been the magazine’s markets editor since 2019.

Alex has a passion for demystifying the often arcane world of finance for a general readership. While financial media tends to focus compulsively on the latest trend, the best opportunities can lie forgotten elsewhere.

He is especially interested in European equities – where his fluent French helps him to cover the continent’s largest bourse – and emerging markets, where his experience living in Beijing, and conversational Chinese, prove useful.

Hailing from Leeds, he studied Philosophy, Politics and Economics at the University of Oxford. He also holds a Master of Public Health from the University of Manchester.