- Analysts tip M&A, interest rate cuts and second-order AI effects to lift market s
Last year was another mixed bag for European equity markets, where returns continued to lag US peers supercharged by the artificial intelligence revolution.
The MSCI Europe ex-UK index delivered an annual return of 7.7 per cent in 2024, beating the FTSE 100’s rise of 5.7 per cent but trailing the MSCI World’s showing of 27.15 per cent.
The STOXX Europe 600 rose 5.98 per cent, as Germany’s DAX 40 delivered a thumping 19 per cent gain but the French CAC 40 lost 2.2 per cent.
Even the DAX 40’s return pales in comparison to the 23 per cent growth enjoyed by the US firms in the S&P 500, while market frenzy over AI helped drive the Nasdaq to a 34 per return.
The Dow Jones Industrial Average climbed a less impressive 16 per cent.
It has become a familiar picture for investors as US stocks have left European companies in their wake in recent years.
But long-suffering investors could be dealt a reprieve in 2025, with some tipping a wave of takeover activity, interest rate cuts and the next chapter of the AI story to turn a new page for European stocks.
Is the worst behind us?
‘Europe has faced numerous challenges and missed opportunities in recent years, including Brexit, the war in Ukraine, and unfavourable demographic trends,’ Tom Wildgoose, senior portfolio manager of global equities at Sarasin & Partners, says.
The past decade has not been an easy one for European investors, and the AI boom across the pond and an over-reliance on imports from China have not helped.
And analysts say valuations in the UK and on the continent are now considerably below their long-term averages.
Wildgoose added: ‘These factors have collectively weakened the performance of European stocks, shifting investor attention toward the US.
‘However, European equities now appear attractively valued compared to their American counterparts, setting the stage for potential recovery.’
Like UK peers, the performance of European stocks has been weighed down by war, soaring energy prices and weak economic performance.
By contrast, high demand US stocks look markedly more expensive.
These attractive valuations could prove a draw for buyers, with analysts eyeing a looming upturn in merger and acquisition activity.
Goldman Sachs says European small and mid-caps have become likely acquisition targets, and therefore should perform well in 2025.
However, the bank cautions they could continue to suffer in the near term on the back of weak economic performance.
Wildgoose added: ‘European industrials are currently trading at a price to earnings ratio (PE) discount that is four points lower than their US peers, a significant shift from parity seen just four to five years ago.
‘A similar valuation gap exists in the consumer sector, further emphasising the opportunity.’
Darius McDermott, managing director at FundCalibre, tips WS Lightman European Fund (ongoing charge: 0.6 per cent) which he says is value-oriented but has delivered top quartile returns over three and five-year periods.
‘Manager Rob Burnett focuses on stocks with low price-to-book and price-to-earnings ratios, combined with high cash flow yields, which he believes are the best characteristics over the long term for European shares,’ says McDermott.
He also tips Liontrust European Dynamic Fund (ongoing charge: 0.85 per cent) as an alternative option for European exposure.
AI trickle down?
The growth of AI has been dominated by US large caps – with Nvidia and its magnificent seven peers proving the stand-out winners from the developing technology.
Chris Elliott, portfolio manager at Evenlode Global Equity fund, said: ‘Many of the seven have been seen as the obvious beneficiaries of the growth of AI, dependent on semiconductor chips and cloud computing datacentres.
‘However, as with all technologies, the ability to monetise the technology depends on other, non-technology businesses.
‘These companies have proprietary datasets and a deep understanding of their client workflows – and a surprising number of them can be found in Europe.’
European companies are increasingly leveraging the power of AI to re-configure their operations, streamline and create opportunities that were previously unavailable to them.
Elliott points to London-listed credit reference agency Experian, which is using its unique sets of data to offer improved products, such as ‘Ascend’ and ‘Clarity’.
These new offerings ‘help their clients make better decisions and reduce the risk of defaults in a negative economic environment’, he explained.
Even small caps, such as AIM-listed maritime tracking firm Windward, which has introduced AI into its tracking system.
It said the technology allows it to reduce vessel screening and investigation times by an average of 20 minutes, having trained the model on 12 years of maritime data.
Just days ago the EU launched a $56million programme in a bid to develop an open-source large language model, leveraging the supercomputing power of several big European players.
This falls short of the billions of dollars that have been pumped into AI development in the US, but is considerably higher than the supposed $6million used to train China’s DeepSeek model.
Defence stocks to keep driving gains
The election of Donald Trump in the US has further complicated the outlook for the Ukraine war, with the President having pledged on the campaign trial to end the conflict ‘before I even become president’.
This might not have come true, but it is likely that he will pursue a deal that sees Ukraine lose land currently occupied by Russia – not an idea the Ukrainian government is overly keen on.
However, Sarasin’s Wildgoose said a resolution to the war ‘could unleash a wave of rebuilding efforts, further boosting economic prospects’.
McDermott said: ‘A ceasefire between Ukraine and Russia could provide renewed stability and boost investor confidence… there is the potential for a significant uptick in European defence spending given Trump’s views on NATO.’
An immediate end to the war is unlikely, with any deal negotiations set to take months, according to Trump aides.
But the President has demanded that NATO members commit 5 per cent of their GDP towards defence spending, a significant uplift from the current 2 per cent goal.
Speaking at Davos last week, Trump said he wasn’t sure that the US should be spending anything on NATO, as the alliance is ‘not protecting us’.
Defence stocks have unsurprisingly been key beneficiaries of the geopolitical upheaval of recent years.
In fact, European defence companies have outperformed their US competitors.
European risers include Thales, gaining 15.4 per cent over the past month, Rheinmetall, which is up almost 25 per cent and Leonardo, which has gained 16 per cent in a month.
Meanwhile, US defence players have fallen in recent weeks. Lockheed Martin is down 2.6 per cent over the month, and General Dynamics has fallen 0.2 per cent over the past month.
German stimulus could provide a boost
Once the powerhouse of the eurozone, the German economy has rapidly become the bloc’s new ‘sick man’ as a manufacturing slump has combined with severe consumer weakness.
This has inevitably weighed on investor perception of the entire region.
Germany’s government is forced to keep structural budget deficits below 0.35 per cent of its annual GDP.
The debt brake, or Schuldenbremse, essentially prevents the state from taking out loans in order to ensure the budget is balanced.
However, with Covid and the war in Ukraine (and the resulting energy crisis) having plagued Germany since 2020, governments have made use of special measures allowing them to go beyond the 0.35 per cent mark.
The debt brake contributed to the collapse of Germany’s government late last year after Chancellor Scholz requested another pause – something that Christian Lindner, the erstwhile finance minister, refused to accept.
But Germany is now on the road to a general election on 23 February, providing hope that the debt brake could face reform.
Charles-Henry Monchau, chief investment officer at Syz Group said: ‘A [Christian Democratic Union]-led coalition might be able to relax the constitutional rule limiting public deficits.
‘This would open the door to a much-needed stimulus plan to revive the German economy that has been stagnating since 2022.
‘Meanwhile, this could also lead Germany to discuss the issuance of European bonds to finance structural investments designed to improve medium-term growth prospects for Europe, following the recommendations of Mario Draghi’s report on the Future of European Competitiveness.’
This outcome, Monchau says, could boost the eurozone and also see a re-rating of European equities.
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