The S&P 500 has posted its slowest opening five months of a year since 2022, gaining just 0.5% between the start of 2025 and the end of May.
The top stocks and funds for investors have been characterised over recent weeks by a decreasing level of US dominance, with investors turning to overlooked regions like Europe instead.
A look at the major headlines of the year to date demonstrates why. Tariff mayhem introduced by Donald Trump has threatened to upend US global economic dominance, and even prompted talk of a US recession.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Prior to that, the emergence of DeepSeek posed an existential threat to the dominance of US mega cap tech companies like the Magnificent Seven.
European stocks, by contrast, have enjoyed their best opening five months during that period this year.
“Trump’s various policy announcements and tariffs have had a profound impact on investor sentiment,” says Marcel Stotzel, co-manager of Fidelity European Trust (LON:FEV). “While we witnessed substantial passive inflows into Europe at the expense of the US at the start of the year, tariffs have introduced significant uncertainty, particularly as the markets anticipate an economic slowdown in both the US and China.”
Despite these dynamics, many European stocks are currently highly undervalued compared to their US counterparts. Various fund managers expect significant tailwinds to further boost European companies in the coming months, and as such they believe that now is the perfect time to buy European stocks and funds.
Why are European stocks outperforming US shares this year?
There is clearly more to European stocks’ relatively high performance through to the end of May than simple pessimism for US stocks, although that has clearly played a part in prompting a capital flight from the US.
“For years, capital flows were largely one-directional: out of Europe and into the US,” said George Cooke, manager of Montanaro European Smaller Companies Trust (LON:MTE).
"However, the resurgence of protectionist rhetoric under the Trump presidency, including the imposition of tariffs on key trading partners and the threat of further escalation, has prompted investors to reconsider the geographic concentration of their portfolios.”
But European stocks are arguably in their strongest position for years in their own right. Ironically, this is partly thanks to unintended consequences of Trump’s policy agenda: “the shift in US policies regarding security and trade have potentially given Europe a wake-up call that will result in greater unity and policy coordination across the continent,” said Stotzel.
This is manifesting, for example, in increased European defence spending. In March, the German parliament agreed plans to spend €500 billion extra on infrastructure and defence over the next decade.
“That’s an absolute game-changer,” Jules Bloch, co-manager of JPMorgan European Discovery Trust (LON:JEDT) added.
“This is a really huge change, and that money will be spent mostly inside Europe.”
Given the years of capital flows from the Europe to the US that have preceded the current setup, European stocks are starting from historically low valuations, especially compared to their US counterparts.
Bloch explained that US stocks – even excluding the tech megacap outliers – are currently trading at the top-end of their historic valuations as measured by historical price to earnings (P/E) ratios, while European stocks (particularly small-caps) are near their lowest levels by the same metric.
“Europe is actually trading at the largest discount to the US in a very long time,” he said.
Which sectors could see the best returns for European stocks?
Bloch believes that European small-caps are best-placed to benefit from any upcoming surge in European stock markets, especially given the additional discounts they are trading at compared to large-cap counterparts.
“We know from history that outperformance comes in cycles, and we believe time has come for European small caps to catch up,” he said.
Events like the German financial stimulus could, he believes, catalyse this process, especially given that small-cap companies tend to be the most correlated with their domestic market in terms of revenue: 58% of European small-cap revenue comes from within Europe, as opposed to 31% for large-caps.
Defence is the most obvious sector in terms of being a direct beneficiary of the Trump-era geopolitical landscape.
“A kick in the backside still moves you forward,” Stotzel told the AIC webinar, referring to the US stepping away from guaranteeing European security under Trump.
“Things like the German fiscal debt brake being lifted were unthinkable six months ago. Germany going north of 3% of GDP and potentially dragging the rest of Europe with it on defence spending was unthinkable six months ago.”
Three investment trusts for exposure to European stocks
All three fund managers advocate slightly different approaches for investing in European stocks.
JEDT invests in European small cap stocks, which Bloch describes as “an asset class with exceptional long-term growth potential, amazing Alpha creation, opportunity trading at various factor valuations, and [which] should massively benefit from the German stimulus”.
Besides its European (ex-UK) small cap focus, the trust is unconstrained in terms of the countries or sectors it can invest in: in Bloch’s words, “we just invest in the stocks that we believe have the highest potential for outstanding returns”.
MTE also has a small-cap focus, and it screens stocks rigorously for both quality and growth factors.
“We like established companies that have barriers to entry,” said Cooke. “We like them to have quality features – the typical things like recurring revenues, good pricing power, high UP and R&D.” But, he adds, the companies need to be growing too: “we are growth investors as well as quality investors, and we like that growth predominantly to come from self-funded, organic growth”.
FEV’s approach is also based around bottom-up stock selection; to Stotzel and the team this specifically means “not taking a call on things like interest rates, currencies, factors like value versus growth”. There is also a dedicated long-term approach, with a minimum five-year holding period in mind when selecting investments.
The trust also takes a conservative approach: “capital preservation is really one, two and three”, said Stotzel.
-
Can Pope Leo plug a worrying black hole in the Vatican’s finances?Pope Leo, the new head of the Catholic Church, takes responsibility not just for 1.4 billion souls, but also for a complex multinational business in deep financial trouble.
-
Donald Trump doubles steel and aluminium tariffs – what does it mean for markets?Donald Trump’s steel and aluminium tariffs will be doubled to 50% from Wednesday. Will the UK be impacted following its trade deal agreement, and what does it mean for markets?
