European shares are up more than 8% this year, led by Germany where the DAX index has rallied more than 12%.
That’s its best start to a year in at least a decade, but the question now is whether those gains will keep on coming.
A key reason for this robust performance has been attractive valuations.
Investors have been lukewarm on Europe for a few years now, and major indices in the region have been trading below their long-term averages.
With the US market rising more than 50% during 2023 and 2024, it’s been very easy to ignore the rest of the world.
However, those stunning gains have made US share prices start to look pricey.
Excluding the abnormal Covid period, valuations (relative to earnings) have reached the highest levels since 2002.
That’s clearly skewed by the Magnificent Seven, which accounts for about a third of the market and has genuinely better growth prospects due to developments in artificial intelligence.
While that makes an apples-with-apples comparison with the past more difficult, investors are wise to assume the gains will slow from here.
This renewed interest in non-US shares has led to a re-rating of the European market, which is now trading in line with its own long-term average.
For this strong start to the year to be sustained, we might need to see a cyclical recovery in the economy, as well as some much-needed structural changes.
After a few false starts, there’s a decent chance that might happen.
We’ve seen the beginnings of a rebound in consumer confidence over the past two months, which bodes well for the excess savings pile in the region.
Lower interest rates will be helping, while also spurring an increase in bank lending.
The European Central Bank (ECB) has cut its policy rate six times, from a euro-era peak of 4.0% to 2.5% today.
It’s expected to fall further, which could have a big impact given Europe’s traditional preference for floating-rate loans.
Another potential catalyst could be a resolution of the war in Ukraine, which we’d all like to see.
That could see the return of cheap Russian gas as a boon for the manufacturing sector, which is still in contraction but is steadily improving.
Europe’s manufacturing PMI (a useful activity indicator) hit a two-year high in February, with the factory sector coming close to stabilising.
We’ve also seen a potentially game-changing announcement out of Germany in recent weeks, with leaders of the reigning political parties agreeing to abandon years of cautious fiscal policy.
Plans for a debt-funded injection into the country’s security architecture and infrastructure sector have come in response to years of underfunding, as well as question marks over America’s future commitment to assisting the region.
That’s pushed longer-term bond yields higher (and prices lower) but if it eventuates, it’s a genuine positive for economic activity, corporate earnings and the sharemarket.
On the other side of the coin, tariffs loom large as a threat to the wider European economy.
The US imposed steel and aluminium tariffs of 25% on the European Union starting this week, while the car industry is bracing itself too.
That’ll undoubtedly be a headwind for growth, although some experts believe the US could also import more from Europe in place of China, Mexico and Canada.
Tariffs could also unify Europe and drive reforms which would be great to see, as hopeful as it is.
After living in the shadow of the US for some time, the prospect of attractive returns from across the Atlantic might be looking better than they have for some time.
Mark Lister is Investment Director at Craigs Investment Partners. The information in this article is provided for information only, is intended to be general in nature, and does not take into account your financial situation, objectives, goals, or risk tolerance. Before making any investment decision Craigs Investment Partners recommends you contact an investment adviser.
