Why is Europe the strongest stock market at the beginning of the year?

At the beginning of 2025, European stock markets have risen, achieving their best performance in a decade, even surpassing Wall Street.

The German DAX index and the French CAC 40 index have both risen by over 9% and about 8% respectively this year, while the STOXX 600 index has increased by more than 5.2% in the past month, far exceeding the S&P 500 index's increase of 2.45%. This marks the first time since 2015 that European indices have significantly outperformed their American counterparts at the start of the year.

Why is Europe the strongest stock market at the start of the year? Analysts believe that the European stock market's valuations are more attractive, corporate earnings are improving, and positions are light. The political and economic outlook in Europe is improving, providing hope for a potential market turnaround.

Luca Paolini, Chief Strategist at Pictet Asset Management, pointed out that European stock markets were previously seen as "uninvestable," but now the political, economic, and earnings outlook has improved. Any positive factor could have a significant impact on the market.

Reassessing Europe: Low Valuations, High Growth Potential

The European economy was nearly stagnant at the end of 2024, and Trump threatened to impose tariffs on Europe, but several factors have led investors to reassess this market, which was once considered "uninvestable."

Compared to the U.S. market, European stock markets have a clear valuation advantage. Recent poor performance of U.S. tech stocks, coupled with the rise of Chinese AI newcomer DeepSeek, has prompted investors to reconsider undervalued markets like Europe. According to LSEG data, the expected price-to-earnings ratio for the S&P 500 index over the next 12 months is 22 times, while the pan-European STOXX 600 index is about 14 times, and the UK stock market is only 12 times.

In addition, the outlook for European corporate earnings growth is optimistic. LSEG IBES forecasts show that European corporate earnings growth is expected to accelerate significantly to 7.9% in 2025, compared to only 1% in 2024 and a decline of 3.9% in 2023. Although the earnings growth expectations for U.S. companies are still higher than those for Europe, the growth rate is slowing. Luca Paolini, Chief Strategist at Pictet Asset Management, stated:

“Market sentiment towards European stocks was once quite pessimistic, and any positive news seems particularly important.”

The "Marginal Sellers" Disappear, Interest Rate Cut Expectations Rise, Strong Buying in European Stocks

In January 2025, capital inflows into European stock markets reached the second-highest level in 25 years, with strong rebounds in stock markets in Frankfurt, Zurich, London, Milan, and Paris, leading to an increase of over 5.5% in the pan-European STOXX 600 index.

Marc Halperin, Portfolio Manager at Edmond de Rothschild AM, stated that market optimism is high, and investor allocations are generally low. He added:

"Where are the marginal sellers? It is currently quite difficult to find, as everyone has relatively low allocations to European stocks."

Research institution SentimenTrader points out that several technical indicators reflecting market breadth (such as the 10-day advance-decline ratio and the number of stocks breaking above the 50-day moving average) have all shown an increase, and historically, this pattern often indicates that the market may continue to rise in the next 1-3 months.

Finally, the market generally expects the European Central Bank to cut interest rates more aggressively than the Federal Reserve. The Bank of England and the European Central Bank have both cut rates in recent weeks, while the Federal Reserve has kept rates unchanged. Lower borrowing costs typically help support economic growth and attract more investors into the stock market.

Long-term Potential Challenges

Marc Halperin, portfolio manager at Edmond de Rothschild AM, believes that given investors' low allocation to European stocks, now may be a good opportunity to increase holdings in European cyclical stocks. He anticipates that factors such as a rebound in economic leading indicators, potential rate cuts by the European Central Bank, and the Federal Reserve pausing interest rate hikes will support European stock performance.

However, market optimism does not mean the disappearance of risks. Altaf Kassam from State Street Global Advisors states:

"The threat of tariffs from Trump remains a significant risk, and if he turns his attention to Europe, it will undoubtedly impact the current stock market rebound."

Although European stocks may continue to perform well in the short term, Michele Morganti, a strategist at Generali Investments, points out that Europe still faces many long-term challenges.

"Such as high energy dependence, corporate governance issues, fragmented energy and capital markets, slow population growth, and insufficient technology investment."

While European stocks have performed well recently, investors still need to be wary of the structural challenges they face in the long term. Over the past 40 years, Europe has occasionally seen rebounds, but these rebounds have often been short-lived, especially after the global financial crisis