The European stock market has been on a strong run, even as recent tariff talks have led to increased volatility. In this analysis, we explore why European equities remain a compelling diversification opportunity, examining earnings growth, valuations, key macroeconomic drivers, and potential risks ahead.
Why European Stocks Matter for Diversification
With valuations still attractive and a shifting macroeconomic landscape, European stocks provide a strong case for diversification. Successful investing isn’t just about identifying the top performer in a bull market. It’s also about finding resilient assets that can hold up during downturns. As policy uncertainty increases, the most speculative parts of the market (expensive momentum assets) tend to be the first to correct, underscoring the importance of geographic diversification beyond the US.
While European stocks have already seen strong gains, sustaining this momentum will require continued earnings growth, stable margins, and a favorable macro backdrop. Investors should monitor corporate performance, geopolitical risks, and policy developments as key factors driving European equities in the coming year.
Europe vs. the US: Divergence
Year-to- date as of March 17th, the Euro Stoxx 50 has gained 11%, significantly outperforming the S&P 500, which has lost -3.8%. Despite making new highs, the rally appears more measured than past peaks. Currently, 74% of stocks in the index are trading above their 200-day moving average- well below the 96% seen in previous market tops, suggesting that momentum, while positive, is not extreme.
European earnings have played a key role in sustaining market momentum. The Q4 earnings season exceeded expectations, reviving EPS growth after a period of stagnation.
While European corporates still lag behind their US peers, especially due to weaker performances in the energy and auto sectors, positive earnings surprises have provided a strong tailwind. Banks have led the way, with names like Santander, Intesa, and BBVA accounting for the bulk of the upside surprises. The tech sector (ASML, Infineon) has also performed well, though luxury giant LVMH and pharmaceutical leader Sanofi have been notable underperformers. Forward EPS estimates have risen modestly for both indices, with the US maintaining a slight edge. Forward EPS estimates need to advance further to support the momentum behind Europe.
While Europe’s improving earnings outlook is a net positive, valuations have re-rated significantly since the start of the year, raising the bar for further outperformance. Profit margins, in particular, will be critical going forward. The recent stock surge has occurred alongside stagnant margins, echoing patterns last seen in 2015 (Graph 1). If companies fail to expand margins in 2025, the rally could lose steam and that is why we currently look at the regional allocation more as a diversification exposure and not an “all-in” play on Europe.
Chart 1. Euro Stoxx 600 Price and Profit Margins
Data as of March 17, 2025. Source: Bloomberg
Certain sectors remain especially vulnerable to external risks. Automakers and luxury goods companies face the biggest threats from tariffs, while industries like mining and beverages could also see headwinds if trade relations worsen.
Political Landscape and Fiscal Support
Germany’s recent election results have been another catalyst for European equities. The formation of a centrist coalition has helped avoid extreme fiscal austerity, paving the way for more balanced, and market-friendly, policies. Additionally, Germany has embraced the need for stronger defense spending, recognizing that Europe must take greater responsibility for its own security. This shift has structural economic implications, with CDU leader Friedrich Merz has proposed a €500 billion special fund to strengthen Germany’s infrastructure and defense, advocating for a reform of the country’s debt brake for investors this is a pure massive stimulus package. That alone triggered a sharp increase in the DAX40 (+3.54%) on the day of the announcement.
Considering all the above, European stocks appear to present an interesting opportunity, supported by the following valuation factors; forward price-to-earnings (P/E) ratio for the Euro Stoxx 50 stands at 15.2x, significantly lower than the S&P 500’s 21x, though still above its long-term average of 12.4x (2006–2024). Another valuation metric, the equity risk premium, suggests that European equities present a compelling risk-reward tradeoff, more so compared to the US.
Risks
However, risks remain. Trade tensions with the US are a major concern, with potential tariffs on European autos and other goods threatening to disrupt momentum. President Trump has previously proposed 25% levies on European automakers, and tariff talks could weigh on investor sentiment. Additionally, skeptics argue that while the rally has been strong, it must translate into sustained earnings growth to remain durable.
This communication is for information and education purposes only and should not be taken as investment advice, a personal recommendation, or an offer of, or solicitation to buy or sell, any financial instruments. This material has been prepared without taking into account any particular recipient’s investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or a packaged investment product are not, and should not be taken as, a reliable indicator of future results. eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this publication.
