Key Points
· The European outlook is lifted by historic fiscal stimulus, including the EU’s €800 billion ReArm Europe initiative and Germany’s €500 billion infrastructure fund. Meanwhile, the ECB’s expected further rate cuts create a more supportive macro environment for growth.
· Macroeconomic indicators are showing mixed signals, of which manufacturing PMI suggests signs of bottoming out, meanwhile consumption is yet to show a convincing recovery.
· The trade tensions add further risk to Europe’s market outlook. However, as the U.S. pulls back from global trade, Europe could benefit by taking on a more prominent role in global commerce, though it still hinges on long-overdue reforms, including the development of larger and deeper capital markets.
· Selected sectors show resilience, such as defence, benefiting from budget hikes; healthcare, supported by sectoral trends; and technology companies with strong, unchallenged positions in the industry.
· Based on our fair PE ratio of 14X, we project a target price of EUR 618 for the STOXX 600 Index, translating to an upside potential of 13.8% by the end of 2027. We maintain the Star Rating for Europe at 2.5 Stars “Neutral”.
European equities have staged an impressive rally, with the STOXX 600 Index outperforming the S&P 500 year-to-date — a reversal of the trend we've seen in 2024. A confluence of policy tailwinds, including fiscal stimulus and rate cuts, has boosted the market outlook.
But after the rebound, the key question remains: is there still room for upside? In this article, we assess the outlook for European markets and whether valuations continue to offer compelling opportunities.
Policy tailwinds lift region’s outlook
The EU has recognised the urgency to pursue military independence amid Trump’s withdrawal of security support from NATO, prompting a surge in defence budgets across the region. At the EU level, President Ursula von der Leyen announced the "ReArm Europe" plan, a fiscal stimulus of €800 billion over four years, aimed at raising defence spending from 1.9% to 3.0% of GDP.
Meanwhile, Germany, traditionally reluctant to take on debt, has exempted defence spending from its fiscal cap and introduced a €500 billion infrastructure fund, marking a significant policy shift. Together, these measures have bolstered sentiment across Europe, with the eurozone manufacturing PMI rising to a 32-month high in April, indicating early signs of a bottoming-out in the industrial sector, further supported by improved industrial production.
Inflation has eased considerably to 2.2% in April from its previous highs of 10.6%, largely driven by a decline in energy prices (Chart 2). Service inflation has also moderated, from 5.6% to 3.9%, reflecting broader disinflationary trends. With inflationary pressures moderating, the ECB is now on track to further cut rates, following seven consecutive cuts, thereby lowering borrowing costs and supporting economic recovery.
Chart 1: Manufacturing PMI rebounds as policy bazooka unleashes
Chart 2: Inflation declines from peak, opening room for further rate cuts
Economic data points to tentative recovery, but further signals needed
Despite the easing of inflation and the improvement in consumer purchasing power, consumption is yet to show a convincing recovery. Retail sales growth remained tepid in the previous months, although the latest March data came in somewhat stronger than expected (Chart 3). Nevertheless, the broader trend still points to cautious household behaviour, with the savings rate remaining well above the long-term average. The need for precautionary savings has increased amid lingering uncertainties—from the Russia-Ukraine war and ongoing trade tensions to the re-election of Donald Trump, which has reignited geopolitical concerns.
European natural gas prices have declined significantly from their 2022 peaks, alleviating one of the biggest post-war cost burdens for manufacturers (Chart 4). Nonetheless, prices remain above the historical averages, continuing to weigh on the region's corporate competitiveness. Manufacturing PMI has stayed in the contraction zone, whether the recent rebound marks a true turnaround or only a tentative recovery, will take further time to prove.
Chart 3: Retail sales growth remained tepid in the previous months
Chart 4: Natural gas price is now below pre-war levels, but still higher than historical averages
Threat of tariff impact on exports
Adding to the uncertainty, escalating trade tensions with the U.S. pose an additional risk to Europe’s growth outlook. The US is the largest exporting destination for EU goods, accounting for over 20% of the bloc’s exports. Following recent U.S. tariff measures, the average tariff rate imposed on EU products could rise sharply from 1.47% to 15.2%, according to Bruegel. As a significant share of the EU’s GDP is tied to exports, the materialisation of these tariffs jeopardises Europe’s growth outlook.
However, the EU retains several cards to play in retaliation against these measures. As one of the United States’ largest trading partners, the EU’s countermeasures could contain or even reverse some of the U.S. tariffs. The EU has already responded with targeted tariffs impacting up to $13.5 billion worth of U.S. exports, carefully focusing on goods from Republican-leaning states—such as soybeans—in an effort to pressure Trump's core political base.
If the situation deteriorates further, the EU has even stronger options, including tightening regulations on U.S. tech firms operating within the bloc. Given that Europe represents one of the largest markets globally for both the products and services of American technology giants, any measures targeting these companies could strike at a core pillar of the U.S. economy. Nonetheless, the EU remains reluctant to escalate the conflict aggressively, maintaining a preference for a negotiated solution despite the confrontational stance from Washington.
More importantly, as the US pulls back from global trade, other countries are likely to diversify their trading relationships and form new alliances. In this context, Europe could play a more prominent role in global commerce. This shift may also support the euro, particularly if it gains traction as a currency for invoicing international trade. A more widely used euro would, in turn, help reduce borrowing costs across the euro area.
President Trump's challenges to independent institutions - such as the Federal Reserve and universities - as well as to the rule of law, have made Europe’s institutional framework appear more stable by comparison. The EU's commitment to the rule of law, with its system of checks and balances, remains a foundational strength. Moreover, Europe continues to show openness to trade and foreign investment.
Widening innovation gap between Europe and US
However, much still hinges on long-overdue reforms, including the development of larger and deeper capital markets. Europe is falling behind in the AI race, with the largest advancements in chips, language models, and AI applications dominated by U.S. companies. A key factor is Europe’s insufficient R&D investment. The gap in R&D spending as a percentage of GDP is widening between the EU and the U.S., driven by Europe’s less developed venture capital market (Chart 5). In 2023, U.S. venture capital funding was three times larger than Europe’s, attracting more AI startups to the U.S. for financing.
With limited access to venture capital and government funding, European startups are often forced to rely on bank loans or seek capital abroad, stifling innovation. Unless substantial progress is made in capital market integration, Europe risks falling further behind in productivity growth compared to other major economies. This challenge is compounded by an aging population, which not only reduces the labour force but also exerts additional pressure on productivity.
Chart 5: R&D investment as percentage of GDP shows a widening gap between EU and the US
Earnings growth remains subdued, though select sectors may see stronger recovery potential
If we take a bottom-up approach and observe the earnings of European companies, while earnings growth remains lacklustre in 2024, there are some bright spots amidst the subdued economic recovery.
Trump's reducing support from Nato and Europe's push for military autonomy signal a long-term paradigm shift, with European defence emerging as a key beneficiary. As the EU ramps up spending to reduce reliance on US military support (Chart 6), European defence companies are expected to see accelerated procurement and expanding order backlogs. This comes on top of the already strong growth trajectory driven by heightened demand following the Ukraine war.
Despite European defence stocks trading at historically high valuations, we believe this is supported by both a structural shift toward defence autonomy and strong earnings visibility. If defence budgets continue to grow and expansion plans are executed as expected, we foresee robust double-digit earnings growth over the next three years. As such, the higher fair PE ratio appears justified, and upside potential remains even after this year’s significant rally.
Chart 6: EU’s proposed a large defence budget hike
Related article: European defence stocks rally amid growing transatlantic divide: A paradigm shift?
Home to numerous multinational pharmaceutical and medical device companies, Europe’s healthcare sector stands to benefit from the surging global demand for weight-loss and diabetes treatments, particularly those developed by Novo Nordisk. Key catalysts include projected record-high sales of weight-loss drugs and advancements targeting higher weight-loss efficacy, both of which could drive strong stock performance.
Related article: Healthcare 2025: Immunise your portfolio for the next wave of growth
Another sector that could deliver stronger performance is technology. Though tech is a relatively small sector in Europe, some key companies play a critical role in their respective field. One company worth mentioning is ASML. It has an unchallenged leadership in lithography, known for its groundbreaking extreme ultraviolet (EUV) lithography machines, adopted by the leading chip manufacturer such as TSMC and Samsung, to manufacture their most high-end chips. Given the complexity of EUV technology and a supply chain that involves hundreds of thousands of components from thousands of specialized suppliers, overtaking ASML will not be easy.
Related article: Why ASML’s future remains bright despite short-term turbulence
Valuation
While macro indicators are yet to show a convincing recovery, select sectors offer pockets of resilience and opportunity. Based on our fair P/E ratio of 14X, we project a target price of EUR 618 for the STOXX 600 Index, translating to an upside potential of 13.8% by the end of 2027 (Table 1). We maintain the Star Rating for Europe at 2.5 Stars “Neutral”.
Chart 7: STOXX 600 Index Price vs EPS
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Table 1: Projections for SXXP Index |
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STOXX Europe 600 |
2023 |
2024 |
2025E |
2026E |
2027E |
|
EPS |
33.67 | 29.74 | 35.00 | 40.26 | 43.54 |
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EPS growth |
2.68% |
-11.76% | 17.69% |
15.03% |
8.15% |
|
PE Ratio |
14.23 |
17.07 |
15.30 |
13.30 |
12.30 |
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Upside Potential |
- |
- |
- |
- |
13.80% |
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Source: Bloomberg Finance L.P., iFAST Estimates |
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Data as of 8 May 2025 |
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Investors who still wish to gain exposure to European equities may consider the Eastspring Investments Unit Trusts - Pan European SGD. Alternatively, a passive approach can be taken with the Vanguard FTSE Europe ETF (NYSE: VGK).
Outside of Europe, we see more compelling opportunities in markets like Japan and Singapore. In the U.S., our sector preference leans towards high-quality companies, Big Tech, and the semiconductor industry.
Related articles:
Liberation day tariff: How US equity investors should navigate the impact
Invest in Japan: A structural opportunity with promising earnings prospects
Singapore in 2025: Riding the Wave of Strong Manufacturing Growth
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