The longer-term case for European equities includes attractive valuations, a genuine fiscal turn, a sector mix suited to today's regime, and income generation, as well as diversification.
The strongest reason to own Europe may have nothing to do with the European macro growth story and more to do with the US has becoming a concentration trade.
Europe has adapted and become more resilient to energy shocks. When the Middle East conflict eases, we believe sentiment toward European assets will improve.
For more than a decade, the European equity story was a bleak one. Slower growth. Comparatively high energy costs. Few technology champions to rival the US. It was a market you may have held for diversification purposes and one you apologised for as it dragged on overall performance.
But it is worth rethinking these assumptions now. The longer-term case for thinking about Europe in a more positive light rests not on a single heroic macro call but rather on valuation, diversification, a genuine fiscal turn, a sector mix suited to today's regime, and income generation.
On most measures Europe is considered cheap. The MSCI Europe ex UK index trades on roughly 15x forward earnings against around 22x for the MSCI USA indexi. The discount reached its widest in decades towards the end of 2024 and began to narrow in 2025. Cheap, of course, does not necessarily mean good value. Some will argue that Europe only looks cheap because it does not have a large tech sector. On a sector-neutral basis, the argument goes that Europe trades much closer to the US. That is only partially true. European banks trade at a discount to US banks, European industrials a discount to US industrials, and the same is true for most other sectors. The valuation gap is not just a function of index composition; it is a valuation difference between the same types of businesses.
Financials, Industrials, and Healthcare are the largest sectors in Europe, unlike the US, these are not indices where a handful of mega-cap platforms carry the largest weight. That is a different market, not a worse one. In a regime of higher rates and more fiscal spending, it is arguably better positioned than a market where a third of the value sits in the AI theme.
We believe the strongest reason for owning is that the US has become a concentration trade. In the US the 10 largest names now account for roughly 35% of the S&P 500; the equivalent figure for the STOXX 600 is about 15%ii. An investor in the US index is, increasingly, an investor in a few highly correlated stories.
The correlation between the US and European markets has reduced over the last year. The correlation between MSCI Europe ex UK and MSCI USA is high enough to get exposure to global equity gains but low enough to genuinely diversify. And, there is evidence of greater stock dispersion within Europe, which potentially provides a fruitful landscape for active managers to add greater value through stock selection.
The rationale for owning Europe is not "Europe becomes the new US". It is simply that portfolios leaning hard on a crowded trade could do with some diversification.
This is the structural change the consensus remains sceptical on. In March 2025 Germany rewrote its constitutional debt brake, allowing defence spending to climb and financing infrastructure and climate investment over 12 years. The significance of these fiscal moves extends beyond Germany. It signals a continent shifting from an austerity mindset to a growth mindset. That should feed capital spending, industrial activity, and the sectors geared into it.
Intellectual honesty demands the caveat: a fiscal commitment is not a fiscal outcome. Execution and timing are real risks. But there is evidence that Germany is spending more on domestically produced military hardware rather than ordering from the US, while permits for German building projects are moving higher. The direction has changed, and direction is what we think will help lift European markets.
Europe will not out-build the US on AI infrastructure, nor is it at the forefront of the latest models. And its listed technology sector is much smaller than in the US. But the AI value chain and the benefits that come with this technology are broader than chip designers and software platforms. Europe is more highly indexed to the enablers and monetisers: the industrial-automation, capital-goods and engineering firms that equip the build-out, and the utilities facing structurally higher power demand to run it.
Utilities are a good example. This is where CapEx is highest in Europe, and while that area has long been penalised on doubts about future return on investment, they are now in demand because powering AI requires the grid and generation they own. Banks, too, are positioned to lend into a fiscal- and infrastructure-led cycle. European loan growth is improving. The point is not that Europe wins the AI race. It is that Europe is not merely a bystander to it.
For investors that want more than beta, Europe can offer a balance sheet and income case the US largely cannot match today, especially when some of the large US tech companies are pulling back on buybacks so they can fund enormous CapEx spending. Aggregate leverage is low and household savings are ample. That resilience should be valued more highly in a higher interest rate world. European households currently have a large chunk of their financial assets sitting in low yielding cash, and we believe that we may see some of these funds trickling into European equities as performance improves.
The equity income gap between the US and Europe is stark too. The S&P 500's dividend yield has fallen to around 1%; European total shareholder yield — dividends plus the region's record pace of buybacks — sits well above that. European banks alone offer a shareholder yield near 8% while trading at just a little above book value. For investors who value total-return discipline and downside protection, being paid to hold European stocks is a strong part of our thesis.
While risks remain, the case for Europe has strengthened
The case for Europe is not perfect. There are risks.
For one, Europe faces higher energy costs due to the conflict in the Middle East. But the impact is thus far much less than in 2022. Europe has adapted and become more resilient to these disruptions over the last four years. More gas is now sourced from Norway and the US and alternative energy production, for example French nuclear production, has increased. The shock is a real cyclical headwind, pushing growth lower and inflation higher, but it is not yet evidence that the broader equity case has broken. When the Middle East conflict eases, we expect sentiment toward European assets will improve.
Additionally, Europe is no longer dirt cheap in absolute terms after a strong run. And challenges compared to the US — less secular growth, higher corporate taxes, less available capital, trade and China exposure — have not vanished.
But investors do not need Europe to be flawless. They need a market that is cheaper than the US on a like-for-like basis, far less crowded, backed by a real fiscal impulse, exposed to sectors that fit the regime, and able to pay income as well as grow earnings. On those measures, the case is stronger than the consensus still allows.
If your portfolio has spent a decade taking the old conclusions as given, this is the moment to rethink. Europe could play a role.
After a strong 2025, can emerging market stocks continue to outperform developed markets in the coming years? We believe they can, thanks to several structural reasons and cyclical factors.
Access MSCI World Index exposure at the lowest cost on the market and benefit from our swap-based replication approach.
Shifting trends underscore the need for a more active approach when artificial intelligence trades are no longer treated as a single trade.
