Can Europe turn recovery into resilience?

Europe Day is held on May 9th every year, celebrating peace and unity in Europe. It marks the anniversary of the Schuman Declaration, which laid out the foundations for European cooperation and was the genesis of the European Union. This year marks 75 years since the Schuman Declaration and comes at a pivotal moment for European nations.

The remainder of 2025 is likely to bring complex choices for the European Union. It must deal with the change in political order that the Trump administration has brought about, and ongoing aggression from Russia on its borders. The situation has prompted a vast increase in defence spending, particularly from Germany, but also from the European Union as a whole. 

In the meantime, domestic governments across Europe must deal with the financial fall out from Trump’s tariffs. Although the US President has dialled back his initial ‘reciprocal’ tariffs on EU countries, European companies are still caught by the universal 10% tariff and the tariffs imposed on specific sectors. 

This has dented confidence among European businesses and derailed a nascent economic recovery in the region. The latest S&P Global flash PMI survey showed the eurozone economy largely flat in April, with business confidence sinking to its lowest level for nearly two and a half years*. It found that manufacturing had benefited from some front-running ahead of the tariff changes, but services were struggling. 

Is optimism ahead for the continent?

Nevertheless, it is not all doom and gloom. European economies should benefit from the stimulus created by defence spending. Equally, they are one of the few major regions that has been able to cut interest rates significantly. Interest rates have come down from 4.5% to just 2.4% in 12 months**. Inflationary pressures have been notably lower than the UK or US. 

Equally, from an investment point of view, Europe has been the clear beneficiary of flows coming out of the US. This has been most evident in flows into ETFs across the region, with a particular strength in defence ETFs. Europe has also delivered notably stronger performance, even with the recent bounce back in US assets. The MSCI Europe is up 10.6% for the year to date, compared to a fall of 1.7% for the MSCI World***. 

Tom Lemaigre, manager of the Janus Henderson European Selected Opportunities fund, asks whether this good start to 2025 can translate into something more meaningful and longer lasting. “European equities are continuing to trade close to record discounts compared to US equities, while international investor positioning remains low – two elements providing a safety net in our view.”

However, he believes the fiscal stimulus won’t be a quick fix: “More time is undoubtedly needed for true structural reforms to improve Europe’s competitiveness, but initiatives in multiples areas – such as easing financial regulation, the capital markets union, and the reduction of general bureaucracy – are also underway with the first results already due in the near term.”

The other swing factor is the potential for peace in Ukraine. Negotiations are ongoing, and there has been a more strident tone towards Russia from the US administration in recent days. Tom admits there are “significant uncertainties around the timing or the exact shape of any ceasefire.”

Nevertheless, he remains positive on European stocks, “Although this view is certainly not without near-term risks stemming from macroeconomic clouds”. He believes the tariffs on Europe are largely manageable for most companies if they remain where they are – with exceptions such as for companies with large South-East Asia production footprints.

David Walton, manager on the IFSL Marlborough European Special Situations fund, also sees a relatively limited direct impact for European companies from the tariff regime: “Looking at the fund as a whole, we estimate goods exported to the US account for 6% of total aggregate sales by our portfolio companies. This suggests a relatively limited direct impact from US tariffs.” 

He believes the greater threat is from a global economic slowdown or recession that results from the US tariffs. His response has been to focus on more defensive companies. “We continue to ensure that the fund is invested in well-managed companies capable of expanding their businesses and with balance sheets able to withstand more difficult trading conditions, should they arise. However, it is too early to judge the scale of any economic slowdown as we do not know yet whether the tariff war will escalate further or de-escalate, and over what timeframe.”

The impact of tariffs is not yet evident in economic data. In the first quarter Eurozone GDP increased by 1.4% year on year****, a notable contrast to the weakness in the US economy. However, ‘Liberation Day’ was only on the 2^nd April. The current (forward-looking) PMI readings for Europe would be consistent with eurozone GDP growing at a quarterly rate of around 0.1% in April. This is not a disaster, but it would be slightly below the average pace seen in the first quarter*. 

Or should investors remain cautious?

For balance, it is worth noting that not all asset allocators are enthusiastic about the revival in Europe. David Coombs, manager on the Rathbone Strategic Growth Portfolio, says he won’t be following the ‘hot’ investment flows into Europe. “The regulatory environment hasn’t changed in the last six months, nor the lack of innovation nor poor productivity levels. Yes, valuations might be lower in Europe, but they should be. We buy European companies that are global leaders.” 

He continues to prefer many US businesses in spite of the uncertainty of the situation there, holding Morgan Stanley and US Bancorp, plus US building equipment hire business Ashtead^. However, he also holds German warehouse kit maker Kion and industrial gas supplier Linde^. He believes the increasingly popular view that this is the end of the US as the dominant global economic power is premature. 

Nevertheless, Europe doesn’t have to become a global superpower for its markets to look attractive. The wayward economic policies pursued by the current US administration are likely to weaken US growth and Europe is the natural beneficiary. 

*Source: S&P Global, flash PMI survey, 23 April 2025

**Source: Trading Economics, euro area interest rate, at May 2025

***Source: index factsheet, 30 April 2025

****Source: eurostat, 30 April 2025

^Source: Rathbones, Clowns and dragons, 29 April 2025