After 2 years of US Exceptionalism, Europe stocks +10% YTD vs. +4% for the US
For the last couple years, the story for equities globally has been one of “US Exceptionalism,” where US stocks have significantly outperformed other markets, in large part thanks to the US-based (and Nasdaq-listed) Mag 7.
Over 2023 and 2024, US equities gained +59% – more than double Europe’s +24% gain (both measured by the MSCIindices of large and mid caps).
To start 2025, though, the US hasn’t been so exceptional.
In fact, it’s Europe that’s doubling up the US, with the MSCI Europe up +10% (chart below, gold line), compared to +4% for the US (blue line).
Europe’s lead is broad based, beating the US across 7 of 11 sectors, tied in 2 more
And it’s not just one thing driving it. If we look at returns this year by sector (chart below), Europe (gold bars) is beating the US (blue bars) in 7 of 11 sectors, and they’re essentially tied in two more (Materials and Real Estate).
So Europe’s leadership is broad based.
AI exposure, higher-for-longer rates, and “expensive” valuations bigger headwinds for US
There are a few different reasons the US has lagged Europe:
- US much more exposed to AI. Tech is 40% of the MSCI USA compared to just 10% for Europe. For the last 2 years, this favored the US, with AI optimism helping the Mag 7 gain +156%. But the Mag 7 is flat this year, in part because DeepSeek’s low cost, high performance model tempered that AI optimism (and the wisdom of Big Tech’s planned $300bn spending on AI this year). Europe, though, is tilted more towards Financials, Health Care, and Industrials.
- US facing higher-for-longer rates as Europe cuts. Markets are only pricing 40bps in Fed cuts this year, compared to 120bps from the European Central Bank (including the 25bps cut they already did). So the European economy is expected to get more of a boost from rate cuts.
- Europe “cheap” relative to US. The US’s Price/Earnings valuation ratio is over 22 – close to record highs during Covid and the Dotcom bubble – while Europe’s PE is just over 14 – close to its 20-year average and about two-thirds the US’s PE. So Europe stocks are relatively “cheap” compared to the US. Plus, higher rates (#2) make it harder to sustain high PEs since higher borrowing costs make future earnings harder to realize.
- European earnings recession over. After seeing earnings fall -2% in 2024, the MSCI Europe is expected to see earnings rise +7% this year. Though that trails the US’s projected +13% earnings gain.
Still, outside of the dimming of AI optimism, most of these factors were already in place to start the year.
So, it’s more a story of Europe recovering (after gaining just +2% last year) than the US slowing down. After all, the MSCI USA is just below its all-time high (set in January), and a +4.3% gain in six weeks isn’t too bad.
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