Is Europe the New Trend?

• Despite uncertainties, the US economy remains solid, with growth of 2.8% in 2024. 
• The influx of investment, stimulated by attractive valuations, supported European markets which outperformed at the start of the year.
• However, in the face of the American and Chinese giants, Europe still has to overcome technological, competitive, and energy challenges.

Despite numerous economic, political and geopolitical uncertainties, it must be said that this year has started with a bang. While the optimism surrounding Donald Trump's inauguration continues to support the equity markets, the US economy has also showed signs of reassurance in January. Indeed, US growth slowed in the final quarter of 2024, recording an increase of 2.3%, compared with the consensus forecast of 2.6%. However, for 2024, the US economy will post solid growth of 2.8%.

At the same time, the labour market is robust, consumer spending remains strong, and business sentiment continues to improve. These factors were more than enough reason for the Federal Reserve to decide unanimously at its first meeting of the year to keep interest rates in a range of 4.25% to 4.50%. The economy is strong, but inflationary pressures remain, justifying a measured and cautious monetary policy stance. The Fed’s decision immediately drew the ire of President Donald Trump who wanted these rates to be cut "immediately". However, the market viewed the announcement as a positive development, and its reaction reflected this sentiment. The announcement of the Stargate project in the US, a massive investment programme of nearly $500 billion in artificial intelligence, was also welcomed by investors and further boosted optimism on the economic front.

In the US, the S&P 500 closed the month up 2.7%, while the Dow Jones Industrials performed even better, rising 4.8%. The Nasdaq underperformed in January, despite the announcement of the Stargate project. The entry into the market of DeepSeek, a Chinese startup that needed just under $5 million to create an AI chatbot that directly competes with the models of major Western tech companies, sent a chill through Silicon Valley, seriously rattling the tech giants. As a result, the Nasdaq closed the month with a modest gain of 1.6%.$

Source: Bloomberg/Heritage

European market performance: unexpected momentum?

January was also witness to another notable event, the outperformance of European equity markets. In fact, the first six weeks of 2025 have seen European equity markets posting their best performance in a decade relative to Wall Street. The Euro Stoxx 50 index closed with a strong gain of 8.1%, while the DAX closed with a gain of 9.1%. After years of underperformance, the Swiss market, represented by the SMI, also showed a remarkable recovery, closing up 8.6%, supported by Richemont (+28%) and Logitech (+21%). In contrast, emerging markets lagged, weighed down by the poor performance of the Chinese market. The Shanghai Composite Index closed the month down by 2.7%.

In the Fixed Income markets, sovereign yield curves showed considerable volatility throughout the month. Inflation expectations initially pushed long-term yields higher, particularly following the proposals in the Trump programme. But December's inflation figures eased investors' concerns, allowing the US 10-year Treasury yield to close slightly lower at 4.53%. In contrast, the yield on 10-year German government bond ended the month higher at 2.46%. Finally, commodities had a strong start to the year, with the Rogers International Commodity Index (RICI) rising 3%. Gold posted a notable gain of 6.6%, continuing to set new highs. Oil also ended the year in positive territory, with WTI up 1.1%.

European markets beat expectations at the start of the year, but challenges remain

European markets have surprised many at the start of the year. Investors have shifted away from U.S. stocks to focus on European companies, capitalizing on significant valuation gaps. The slump in US technology stocks also played a key role in this inflow of capital, as did Donald Trump's commitment to finding a quick solution to the conflict in Ukraine. Nonetheless, it is important to remember that Europe has seen occasional rallies over the past 40 years, but these have often been short-lived, especially after the global financial crisis. While European equity markets have underperformed in recent years and are trading at attractive valuations, we believe these valuation gaps reflect a number of significant challenges that the Old Continent must overcome if it is to regain its attractiveness.

Source: Bloomberg/Heritage

Europe, although a leader in certain technological sectors, remains behind, particularly compared to the United States and China, due to several factors. While it excels in fields such as aerospace and renewable energy, it faces increasing competition in key areas like cybersecurity, artificial intelligence, and biotechnology.

The United States and China have a clear advantage in technological innovation, supported by massive investments in R&D over many years, significantly more mature venture capital markets, and robust government policies which foster investment. In Europe, although there are many research centres and innovative companies, competitiveness remains a major challenge. The per capita income is 27% lower than in the United States, and the European Union struggles to bridge this gap.

To compete with these giants, the Eurozone has no choice but to strengthen its investments in innovation. Closer cooperation between its member states and the establishment of common policies are crucial. It is also essential to increase public and private spending on innovation, attract talent, and ensure strategic access to necessary materials.

Finally, Europe’s low energy self-sufficiency constitutes a significant vulnerability. Although it has reduced its imports of Russian gas since the conflict in Ukraine commenced, Europe largely compensates for this decline with imports from the United States, something which exposes it to price fluctuations and geopolitical risks. This energy dependence weakens Europe’s competitiveness, both economically and strategically. European states must urgently address this issue by diversifying their energy sources, investing in renewable energy, and developing local alternatives to strengthen their position against the United States and China.

Faced with low economic growth and an obvious lack of competitiveness, the European Commission presented a new strategy at the end of January 2025 to revitalize its economy. Named the “Compass for Competitiveness,” this initiative focuses on three main areas: innovation, decarbonization, and security, with the goal of repositioning Europe as a key player on the global stage within the next five years. However, the divergences between member states make this ambition difficult to achieve.

Indeed, compared to the United States and China who have long understood the strategic importance of new technologies and innovation, Europe struggles to compete. These two powers can act unilaterally in these areas without needing to secure constant consensus, something which gives them a significant advantage.

In conclusion, European markets, although attractive, have not yet reached a tipping point where a long-term trend can be discerned. While the rally observed in recent weeks is healthy, it is still too early to say that Europe has found the key to closing its competitivity gap with the American and Chinese giants.

👉Downlaod the CIO Letter: CIO Letter - February 2025