European Equities Revival

For many years, European equities have been in the shadow of the US stock markets. A stronger pro-business culture, less regulation, a broader talent pool as well as more innovation fuelled by access to capital and higher investments has led to significantly better earnings growth for US companies and thereby fuelling better stock market gains. However, after years of lacklustre economic growth, political indecisiveness, and overregulation, we are under the impression that Europe has finally turned a corner for the better. While European stocks have done particularly well this year, we do not see this as a short term fluke but rather see this as the beginning of a prolonged attractive performance phase.

1. Winds of Change are Evident – Corporate Confidence on Europe is Rising

Nowhere has the newfound European optimism and genuine shift in mindset been more evident than in recent discussions with the management teams of some of Europe’s largest companies (Source: BNP Paribas CEO conference, June 3-5, 2025):

Deutsche Boerse: “Six months ago there were no IPOs, no interest in Europe and its capital markets. Now this has changed and there is so much interest for these beautiful businesses.” (Stephan Leithner, CEO)

Ryanair: “Closing bookings are strong, closing pricing is strong... Forward bookings are strong, pricing is rising.” (Michael O’Leary, Group CEO)

Heidelberg Materials: “The new German government is a clear positive for us in the region. Now we need to see that countries like France come back into play as cement volumes are at historically low levels.” (René Aldach, CFO)

L’Oreal: “Europe - so far has been great. UK is a bit slower, S Europe is super dynamic, Eastern European pretty dynamic. Overall can still count on Europe. Still gaining share. Continue to see Europe as a growth driver.” (Nicolas Hieronimus, CEO)

2. Economy: Cyclical Recovery Underway, but Structural Reforms Drive Mid-Term Growth

After several years of lacklustre growth and political indecisiveness, we think that Europe has taken a turn for the better and expect an improvement in economic growth over the coming years. Our view is supported by both near-term leading indicators and emerging structural reforms. We think this convergence of short-term cyclical indicators combined with a higher investments as well as more institutional change in the medium term should help reduce the prevailing growth gap between the US and Europe in the years to come.

2.a. Short-Term Momentum: Cyclical Recovery Gaining Traction - Rebound in Manufacturing Activity

Forward-looking indicators point to a near-term recovery in the industrial sector. The ratio of new orders to inventories has moved back above 1—typically a lead indicator of manufacturing PMI by around three months. With services already expanding and inventory overhangs largely resolved, a broad-based PMI improvement appears likely.

2.b. Mid-Term Tailwinds: Policy Shifts and Institutional Reform

1. Fiscal Expansion in Germany

Germany, long criticized for fiscal indecisiveness, is now embracing public investment. This pivot is triggering a broader shift in sentiment and providing corporates with the confidence to re-engage in capital expenditure. Speaking to multiple companies over the last couple of weeks, there is a clear sentiment shift towards more optimism and higher willingness to invest.

2. Regulatory Easing in Brussels and Berlin

After years of growing regulatory pressure, a shift in tone is evident. Both EU and German authorities are scaling back bureaucratic hurdles—raising thresholds and simplifying compliance—thereby fostering a more business-friendly environment. In one of several EU reforms, a new “small mid‑cap” category exempts roughly 38,000 firms across the EU from select GDPR, MiFID II and prospectus obligations—unlocking an estimated EUR 400 million in potential annual compliance savings. A further example is the European Saving & Investment Union, which ultimately aims to mobilise European savings towards more productive investments.

3. Strategic Trade Realignment

Geopolitical friction—especially the renewed threat of US trade protectionism—has prompted the EU to accelerate trade diversification. The long-stalled Mercosur trade deal, for example, has a stronger chance of ratification, reflecting a broader push to deepen ties with non-US partners.

4. Internal Cohesion Improving

External pressure, notably from the Trump administration, has galvanized greater unity within Europe. From a coordinated stance on Ukraine to defence and trade cooperation, the bloc has shown renewed coherence. Re-cent UK-EU agreements underscore this progress.

A Narrowing GDP Growth Gap with the US

We do not expect the Eurozone economy to outperform that of the US. However, the growth gap will likely narrow significantly. Driven mostly by the German turnaround, our economists project Eurozone growth to accelerate modestly from 0.8% in 2024 to 1% this year, 1.4% in 2026 and 1.5% in 2027. This projection aligns closely with the IFO Institute’s updated forecast for Germany, which almost doubled its 2026 GDP growth outlook to around  1.5%. In the US, tariffs will likely remain significantly higher than they were before Trump returned to the White House, probably with an average extra tariff of c10% on most goods imports from most countries and a some-what higher base tariff on most deliveries from China, even if Trump strikes the deals we expect. Without falling into stagnation or worse, the US economy looks set to lose some momentum as a result.

3. Earnings Growth Expected to Accelerate and Broaden — A Positive for Our Holdings

Before we look at the earnings outlook for the coming years, we should first analyse the reasons for the historic performance gap between the two continents.

Long Term European Underperformance Driven by Weaker Earnings Growth

Over the past five years, the MSCI USA has outperformed the MSCI Europe by nearly 25% in local currency, largely due to stronger earnings growth. A sector-level breakdown reveals that the only notable exception to this trend is financials: European financials posted an impressive EPS CAGR of 9.3%, far ahead of the 3.6% seen in the U.S., and outperformed their U.S. counterparts by 60% in price terms. Outside of financials, however, the U.S. led or matched Europe in earnings growth across all other sectors. This was especially evident in information technology (32% of the U.S. index) and communication services (10%), where earnings growth, and the corresponding price performance, was markedly stronger. This trend is further supported by earnings revisions, which have consistently favored the U.S. over the past few years, reinforcing its dominant performance.

Domestic Value Drives Europe’s YTD Outperformance, Despite Muted Earnings Momentum

Year-to-date, European equities have outperformed the U.S. by 8% in local currency (18.5% in EUR terms). This comes despite slightly steeper earnings downgrades in Europe for 2025 (-6% vs. -4% in the U.S.). U.S. markets have been weighed down by tariff uncertainty and recession fears, while Europe has begun to reflect mid-term tailwinds from increased investment and supportive regulatory shifts.

Beneath the headline figures, style and size dynamics diverge sharply between regions. The U.S. saw a rotation back to growth leadership post-"liberation day," whereas European value stocks—especially those with low tariff exposure—have shown relative resilience. Strong performance has come from domestically focused names, particularly in financials, utilities, communication services, as well as industrials and materials supported by better economic indicators and government investment in infrastructure and defense.

European small caps have also outpaced large caps, thanks to their domestic tilt. In contrast, U.S. market leadership remains concentrated in IT, communication services, consumer discretionary, and industrials, with sectors like banks, utilities, and materials—strong in Europe—underperforming. The U.S. has also seen a much narrower gap between small- and large-cap performance.

Earnings Growth Gap to Decrease due to Better Top Line Growth as well as better Margin Improvement

Going forward, we think the earnings growth gap between Europe and the US will decrease as is already evident in the current consensus forecasts for 2026 and 2027. While revisions for 2025 have been more negative in Europe than in the US, the actual earnings growth of the two continents has been quite similar over the last three quarters. Something that was certainly not the case in the quarters before as seen in the below graph.

The main reasons for the improved growth rates in the future will be the first real impacts of the German spending plan, the overall higher business confidence leading to increased capital investment as well as the continuously improving order trends within the manufacturing space. This should lead to a broadening of organic sales growth rates in particular for our key investment areas of small cap stocks, industrials, IT and consumer discretionary. Besides better sales development we think that regulatory easing as well as solid operating leverage (as many European companies operate with high fixed costs) should support further margin expansion While absolute growth may remain moderate compared to the US or emerging markets, the delta—the change in earnings trajectory—is where opportunity lies.

4. Valuations Remain Attractive, Particularly in Small Caps

Let us first look at the main reasons for the historic valuation gap across the Atlantic:

1. Lower Earnings Growth: Historically, European companies have exhibited lower earnings growth compared to their US counterparts, leading to lower valuations. US sectors like IT and Communication Services have demonstrated significantly stronger earnings growth, attracting higher valuations.

2. Significantly lower ROEs in Europe: Comparing the European vs. the US stock market, there is an ROE gap of roughly 5% (12% in Europe vs 17% in the US), which cannot simply be explained by higher ROE sectors having higher relative weights. Even when comparing sector for sector, the only two sector where Europe is leading over the US is healthcare and utilities. The difference is particularly staggering when looking at the gap in the IT sector where US companies are able to achieve an impressive 29% ROE vs. 11% in Europe. A similar picture is found in Consumer Discretionary as well as in staples with double digit ROE GAPs.

3. Sectoral Composition: The US market is heavily weighted towards high-growth sectors like technology, which command higher multiples. In contrast, European markets have a larger proportion of slower-growth sectors or sectors perceived as riskier. However, even adjusting for sector neutrality, there is still a significant potential to catch up.

4. Risk perception: Europe has often been perceived as riskier due to political instability, regulatory burdens, and economic fragility. The Eurozone crisis and Brexit have contributed to this perception, leading to a discount in valuations.

While we do not expect the valuation gap to close completely, we see several reasons for it to narrow:

1. Improved Earnings Growth and better ROEs: As discussed beforehand, we expect the earnings gap to narrow. With stronger earnings growth and improving return on equity (ROE) in Europe, higher valuations are increasingly justified.
2. Policy and Regulatory Changes: Fiscal expansion in Germany and regulatory easing in Brussels and Berlin are creating a more business-friendly environment, which could boost investor confidence and valuations.
3. Return of Capital Investment: Increased business confidence is leading to higher capital investment in Europe, which should drive economic growth and improve earnings.
4. Fund Flows: After years of outflows, assets are returning to Europe. As international investors continue to rebalance away from U.S. markets to Europe, this should act as a strong support for valuations.

We therefore conclude that, while a certain valuation gap will most likely continue to exist across the Atlantic due to a better sector composition towards high ROE sectors, overall higher levels of ROE (expected to improve from the current 12% towards 14% in 2027) and better total earnings growth, we see ample reasons to expect a narrowing from the current, historically cheap levels. This is particularly the case for European Small caps who have been hit overproportionally by the weaker economic climate as well as higher outflows and now trade at levels that have hardly been seen since the Euro Crisis.

5. Flows Returning to Europe with additional mid-term upside by the proposed European Savings & Investment Union (ESIU)

From the beginning of 2022 until the end of 2024, European equity funds have seen outflows of roughly 16% of AUM. Particularly the European Small Cap space has been hurt by these withdrawals. However, since the start of the year, there has been a significant reversal with net inflows into Europe of roughly 2.5% of AUM - driven by the previously described more positive structural outlook on Europe, particularly in comparison to the US.

While this might already seem substantial, we think that these flows might mark just the beginning of a broader reallocation trend. Consider the following:

Over the past 5 years, international ownership of US equities has increased by 5 percentage points from 25% to 30%. Assuming that over the next 5 years, international investors will reduce their US ownership by just 3 percentage points and seeing 2/3 of these flows going to Europe, this would imply €1.2trn of additional inflows into European stocks, which would be 6% of the total European market cap. It is needless to say, that if such a move were to happen, even if it were to happen in parts, this would be substantially positive.

Besides the potential for further flows coming back to Europe, we are very optimistic on the current development regarding the proposed Initiative of the European Saving & Investment Union (ESIU). Initiated by the European Union, it aims to address structural shortcomings in the European Union’s capital markets by mobilizing private savings and channelling them more efficiently into productive investments. While in the past there has been a lot of talk without any substantial results coming off it, the most recent, market-friendly proposal of the European Securitisation framework by the European Commission is testament that the regulating bodies are serious about mobilising more private capital to be invested across the continent.

6. Our European strategies are particularly well suited to capture this European renaissance

Our performance analysis confirms that sustained earnings growth is the key to long-term outperformance. As short-term market euphoria fades, we expect a clear divergence between companies that can deliver on their growth promises and those that cannot.

Detailed information on the opportunities and risks of these funds can be found in the sales prospectus. The sales documents can be requested free of charge in German from Universal-Investment-Gesellschaft mbH and Joh. Berenberg, Gossler & Co KG (Berenberg), Neuer Jungfernstieg 20, 20354 Hamburg, and are available on the Internet at www.berenberg.de/fonds/.