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Written by: Nelson Edwards and Mary Park Durham
Eurozone equities are on an exciting upswing this year, already climbing by 15.1% compared to only 3.4% in 2024. What’s fueling the rally? As discussed in this blog, fiscal and structural factors are driving an increase in growth and earnings expectations.
While nearly every sector in MSCI EU is positive year-to-date, it’s helpful to examine the two sectors that are driving the lead:
- Defense and Aerospace: Due to the Russia/Ukraine conflict, the Eurozone Aerospace and Defense industry has seen impressive returns, even outperforming U.S. growth stocks by 100% on a cumulative basis since fall 2022. This year, it has also been one of the EU’s top performers, with the recent U.S. military assistance withdrawal from Ukraine intensifying the urgency for EU policymakers to act. The EU is proposing 800 billion euros for defense initiatives, including 150 billion euros in loans to “ReArm Europe1.” Importantly, political parties in Germany have agreed to allow defense spending above 1% of GDP to be excluded from the debt brake limit. These developments have set the stage for a dramatic re-rating in the sector, as spending expectations rise.
- Banks: A few years ago, Eurozone banks were struggling to recapitalize after the sovereign debt crisis, amid strict Basel III regulations and a negative/zero interest rate backdrop which hampered profitability. The landscape today could not look more different, with recapitalized European banks having returned 200 billion euros in buybacks2 and dividends to shareholders in 2024, while recently surpassing the ROE of U.S. banks, supported by higher interest rates and fee income. Investors have been rewarded by the rebound – Eurozone banks have returned 34.7% YTD, and 125.7% since the beginning of 2023. Despite this, Eurozone banks continue to trade drastically cheaper than their U.S. counterparts, trading at 1.0x book value, versus 1.5x for U.S. banks.
Despite strong momentum in certain sectors, the sustainability of the rally remains uncertain. Firstly, we’re not yet seeing a clear sign of a cyclical recovery, with PMIs still hovering around 50. Additionally, potential U.S. tariffs could further threaten growth, as the EU economy heavily relies on exports, which accounted for 38% of nominal GDP in 2023, although exposure to the U.S. is much lower.
However, higher government spending will likely be a key feature of the next decade in the Eurozone, with Germany’s debt brake reform and the EU Recovery Fund. As a result, JP Morgan analysts have revised their 2025 and 2026 Eurozone GDP growth forecasts up. For now, the YTD rally is indicating that expectations for the EU have been too weak, and the steep valuation discounts across sectors may not be justified.
Eurozone bank and defense stocks have been outperforming U.S. growth stocks for 2+ years.
Total return, USD, Oct. 12, 2022 = 100
Source: FactSet, MSCI, J.P. Morgan Asset Management. U.S. growth: Russell 1000 Index, Eurozone banks: MSCI EMU Banks Index. Eurozone: MSCI EMU Aerospace and Defense Index. Oct. 12, 2022 = recent market bottom for U.S. equities (S&P 500 Index).
Data are as of March 10, 2025.
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1 The "ReArm Europe" plan is set to allocate approximately 800 billion euros in public funding to bolster defense initiatives. Read more here: https://ec.europa.eu/commission/presscorner/detail/sv/statement_25_673
2 Bank of America Equity Research. European bank buybacks totaled 120 billion euros in 2024, a record high.