Summary 

• 2024 was a challenging year for European markets characterised by a subdued macro-economic climate, political instability, and global geopolitical tensions. While some of these challenges persist, we see a range of catalysts that could create attractive opportunities in European equities. 
• European valuation multiples are at historic lows relative to the US despite improving corporate fundamentals and lower reliance on domestic economies, offering room for incremental improvement over the year. 
• Falling inflation and lower interest rates could help boost the corporate funding environment and capital expenditure, and lift consumer confidence, supporting a structural advance in equity markets. 
• The evolution of artificial intelligence (AI) offers exciting opportunities for many European companies, potentially improving the growth outlook for the region. 

2024 was a challenging year for European Equity markets, characterised by lacklustre business activity, political instability after the announcement of French and German snap elections, the re-election of protectionist-oriented Donald Trump in the US, and ongoing geopolitical tensions on Europe’s doorstep. Despite these challenges, European equity markets delivered returns of over 8%; however, this significantly lagged the performance of global and US markets, leaving European equities continuing to look cheap compared to their US counterparts. 

Early in 2025, European economic growth remains under pressure, challenged by poor credit growth and depressed consumer confidence. However, from a weak starting point, a cyclical upswing could be around the corner for Europe. 

Falling inflation and lower interest rates could help boost corporate capital expenditure and lift consumer confidence. Europe’s manufacturing recession is one of the longest in decades, however, there are signs that it may be nearing the end. Stronger real disposable income and easing financial conditions could facilitate the release of elevated excess consumer savings to spur consumption growth. However, potential tariffs to be levied by President Trump remain a key risk as Europe is likely to be the next target. Against this mixed backdrop, we identify opportunities in European equity markets for the year ahead. 

Why investors should consider European equities now

The European discount  

European valuation multiples compared to the US’s are at historic lows. In early February 2025, the MSCI Europe index was trading at a 12-month forward PE ratio of 13.3x; a 40% discount to the S&P 500, which was trading at 22.3x¹ . 

In the US, narrow market conditions and companies with strong ties to artificial intelligence (AI) or those perceived to be beneficiaries of policies from the Trump administration are leading equity returns, resulting in rich valuations. Even if we strip out these differences in concentration by comparing US and European equal-weighted indices, the latter still screens at a valuation discount of 30%². Some of this discrepancy is explained by the market’s belief in US exceptionalism in contrast to Europe’s subdued economic outlook. 

Resilient economic data, strong corporate earnings, falling inflation and easing monetary policy have supported US equities, but we are starting to see the market’s conviction in US dominance waver. By contrast, the degree of pessimism towards Europe may be overplayed given that core inflation is contained, and lower interest rates help boost corporate capital expenditure and lift consumer confidence. As such, there may be upside for European stocks on any incrementally positive news flow. 

Figure 1: European equities historically cheap relative to the US
 

Tide is turning in unloved sectors

To understand where prime opportunities lie from Europe’s unusually deep valuation discount requires a closer look at the sectoral breakdown. On sector-by-sector basis, it is not true that the entire market trades at a significant discount to the US; for example, technology and healthcare do not screen as extremely cheap. Rather, it is unloved companies in domestically focused sectors such as retail-orientated financials and utilities that explain the difference. To illustrate this point, IT and health care trade at discounts of 11% and 13%, respectively, to the US, based on 12-month forward PE ratios. By contrast, utilities and financials trade at more pronounced discounts of 32% and 62% respectively³.

A disciplined and bottom-up approach to stock picking can identify opportunities within these sectors. In European banks, for example, the higher interest rate environment has supported net interest margins and banks are starting to distribute profits to shareholders now that they have a much stronger capital base than following the global financial crisis (GFC). Some parts of the market still perceive that banks have poor quality earnings given the experience during the GFC. While banks are exposed to the business cycle, the quality of earnings of some banks is substantially better than it has been in the past 15 years, and we believe this is not fully appreciated by investors. Over time, we expect the market to recognise these changes.

Potential benefits from lower interest rates

The ECB expects eurozone inflation to be close to the 2% target from Q2 2025 as the effects of past energy price shocks and labour cost pressures fade, and the lagged effects from monetary tightening continue to feed through to consumer prices. This would provide cover for the ECB to continue cutting interest rates, which would encourage business and consumer spending. Indeed, the current household savings rate in Europe is 15.6% - around 3% above average. Any reduction in the savings rate towards its historical mean could deliver a meaningful uplift to GDP growth.

Fidelity’s macro team expects the ECB to cut rates this year more aggressively than the market is pricing, which should boost capital intensive sectors such as industrials as companies take advantage of cheaper financing conditions.

End in sight for Europe’s industrial recession

The weak economic environment in Europe has been driven predominantly by soft industrial demand. Europe has experienced one of the longest industrial recessions on record, with the Purchasing Managers’ Index (PMI) last seen above the expansionary 50 level in June 2022. However, sentiment is improving with January’s composite PMI creeping marginally into expansion at 50.2. While the manufacturing sector remains in negative territory, January’s contraction was the smallest since May last year. These readings offer signs that Europe’s industrial recession is past its trough. 

The Institute for Energy Economics and Financial Analysis predicts that lower demand growth and new export capacity coming onstream will push the LNG market into over-supply within 2 years, removing the pressure on natural gas prices and improving costs for businesses, particularly for energy intensive industrial sectors such as chemical and fertiliser producers, steel, and tyre manufacturers. In addition, a potential resolution to the Ukraine war would reinforce falling energy prices and support the idea that the industrial recession could be nearing its end. A potential ceasefire between Russia and Ukraine would also lead to a reduction in risk premia for many European stocks.

Europe is set to benefit from AI

Strong US stock market returns have been led by a narrow cohort of high growth US mega cap companies (‘The Magnificent Seven’), fuelled in part by the growth of AI. This performance has led to extreme concentration within the index and rich valuations of mega cap tech stocks. 

To support further advances in AI, the biggest US technology companies (AI enablers) have committed to vast capex. However, the release of DeepSeek’s R1 model in January and the development of low-cost AI models have made investors nervous around whether the expected investment returns of these ambitious capex plans by richly valued companies are justified. Any weakness in US mega cap stocks could serve as a tailwind for European markets as investors reallocate their capital. 

If concerns over the valuations of US tech play out and there is a market correction, the sectors that historically fair best during periods of US tech underperformance are US and European consumer staples, health care and energy; supporting the argument that the spread between US stocks and European stocks could narrow.

By contrast, in Europe we see interesting opportunities related to AI. Industrial equipment businesses such as Legrand provide critical infrastructure for data centres and are a less appreciated play on the theme. More broadly, falling costs of AI adoption could benefit many European companies as they adopt AI to realise operational efficiency gains. For example, academic publishing, information services and exhibitions company RELX has deployed AI and machine learning tools to offer new services to its customers. 

Small-cap comeback 

Easing credit conditions offer attractive prospects for European smaller companies, which have underperformed their large cap peers. The possibility of further monetary easing adds to what is becoming a compelling case to rethink allocations to small and mid-cap companies.

Historically, small and mid-size stocks tend to outperform during periods of declining rates as they rely more on bank lending than credit markets to raise capital. Therefore, lower interest rates could unlock new and better investment opportunities for these companies to enhance their long-term prospects, while lower interest expenses could boost earnings in the near-term. In addition, easing credit conditions could help extend the rise in M&A activity that we saw through 2024, benefitting the European small cap market. 

To invest in Europe is to invest in the world 

The revenue exposure of the MSCI Europe Index is geographically diversified, and, notwithstanding local economic and political contexts, there are many attractive European companies with globally diversified revenue streams. That said, the threat of US tariffs on European goods are a concern. The US is Europe’s largest trading partner and tariffs could trigger a negative demand shock in Europe and reignite inflationary pressure, especially if tariffs result in euro weakness against the US dollar. However, early signs that Trump is prepared to negotiate with China and Mexico over looming 25% import tariffs offer some hope that the US will take a softer stance than feared on Europe. 

Chart 2 - 60% of corporate revenues in MSCI Europe are generated outside the region

The key features of our European equity capability 

• Fidelity International is the largest manager of active pan-European equity funds in the world⁴. This provides a scale and breadth of resource that enables superior corporate access and client service. 
• Our portfolio managers draw on the expertise of Fidelity’s in-house team of European equity analysts: 33⁵ sector specialists are responsible for deep dive due diligence and work with their global counterparts to provide truly comprehensive stock coverage. 
• Our focus on bottom-up stock selection is underpinned by risk management. The search for quality is core to our investment philosophy and seeks to reduce the risks of permanent loss of capital.
• Integrated financial and ESG analysis captures the full range of fundamental factors driving financial performance and long-term shareholder value.
   

Source

¹ Source: LSEG Datastream, 7th February 2025
² Source: LSEG Datastream, 7th February 2025
³ Source: LSEG Datastream, 7th February 2025
⁴ By assets under management. Refers to funds sold cross-border.
⁵ Source: Fidelity International as at 31 December 2024.

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