As US stocks hit new highs, European stocks lose their advantage, but don't forget about the euro

According to the Zhitong Finance APP, at the beginning of 2025, driven by the erratic policies in the United States and Germany's once-in-a-century fiscal policy shift, European stock markets briefly outperformed U.S. stock markets. However, U.S. stocks have now caught up. As of last Friday's close, the pan-European Stoxx 600 index has risen 6.6% so far this year, while the S&P 500 index has increased by 6.8% during the same period. In March, the pan-European Stoxx 600 index had outperformed the S&P 500 index by as much as 10 percentage points.

Although the advantage of European stocks over U.S. stocks is no longer present, Europe still retains an advantage in terms of exchange rates. So far this year, the euro has risen 14% against the U.S. dollar. Max Castelli, Head of Global Sovereign Market Strategy at UBS Asset Management, stated that the key test for the rotation of assets between the U.S. and Europe lies in trade negotiations and the new tax cuts and spending bills introduced in the U.S. He said, "I don't think the 'American exceptionalism' will return with the same strength and intensity, but I also wouldn't rule out the possibility that this significant outperformance of European assets relative to U.S. products has come to an end."

Here is a detailed analysis of the performance comparison between the U.S. and European markets.

Tech Stocks Make a Comeback

Marija Veitmane, Head of Equity Research at State Street Global Markets, stated that the U.S. stock market began to rebound in mid-April, partly because "the trade war turned into trade negotiations," but "the real turning point" occurred during earnings season when "CEOs of tech companies stood up and said 'our earnings will be very strong.'"

The technology sector accounts for about one-third of the S&P 500 index. Since early April, this sector has risen 24%, despite experiencing a sharp decline due to President Trump's announcement of so-called "reciprocal tariffs." NVIDIA (NVDA.US) has once again become the world's most valuable company, with an astonishing increase of 45% since early April, while there are hardly any companies in the European market that can compete with it.

Maintain Composure

Despite the S&P 500 index reaching an all-time high, not all investors are eager to return to the U.S. stock market, indicating that current valuations may be too high. Madeleine Ronner, Senior Equity Portfolio Manager at DWS Asset Management, stated, "Trump's tariff statements show how quickly market sentiment can change, and how dangerous these high valuations (of U.S. stocks) can be." She added that valuations in the European market are more reasonable Despite the previous valuation gap seeming reasonable—due to slow earnings growth among European companies—she pointed out: "Now that European earnings per share (EPS) are starting to rebound, this gap is narrowing, and valuations should reflect this change." DWS expects that the GDP growth rates of the U.S. and Europe will be roughly comparable in 2025 and 2026, providing sustained support for European corporate earnings.

Can we continue to buy defense stocks?

Investors have heavily bought European stocks, but mainly concentrated in a few sectors. Among them, the defense sector has risen 50% this year, and the banking sector has increased by 28%, far exceeding the overall European stock market, indicating that investors remain cautious about the broader market. According to estimates from BNP Paribas, these two sectors, despite only accounting for 16% of the pan-European STOXX 600 index, contributed over 50% of the returns.

This is not surprising, as NATO member countries have agreed to increase defense spending, especially Germany. However, currently, the valuation of the defense sector is already high. For example, the forward price-to-earnings ratio of German defense giant Rheinmetall has exceeded 50 times; in contrast, the forward price-to-earnings ratios of Apple (AAPL.US) and Microsoft (MSFT.US) are only about 30 times.

Euro more favored

The situation regarding exchange rates is clearer. The euro to U.S. dollar exchange rate is currently close to a four-year high, nearing 1.20. Earlier this year, many analysts predicted that the euro would fall below parity against the dollar, as demand for U.S. assets seemed extremely strong at that time.

However, when this trend reversed, the euro began to appreciate. As foreign investors holding U.S. stocks and bonds grew concerned about the dollar continuing to weaken, they began to strengthen their currency hedges, making the euro's appreciation trend more pronounced.

Now, even without further capital outflows from U.S. assets, the euro is still favored. George Saravelos, head of foreign exchange strategy at Deutsche Bank, wrote in a report: "Foreign investors do not need to sell U.S. assets to depress the dollar; just saying 'thank you, no more purchases' is enough."

Exchange rates are crucial

Exchange rate changes also affect stock market investors, making European stocks cheaper for U.S. investors, while U.S. stocks become more expensive for European investors. Although the S&P 500 index is at a historical high for U.S. domestic investors, when priced in euros, its level is 9% lower than the peak in February On the other hand, although the pan-European Stoxx 600 index has not yet returned to its historical high in March when measured in local currency, it reached a record high in late June when priced in US dollars.

Madeleine Ronner stated, "For investors priced in euros, the exchange rate has almost swallowed up all their returns on US assets this year." "If the market experiences another pullback, it will be even worse when converted to euros."