Investing & Performance | 6 March 2025

Monthly update: European markets outpace US counterparts

A brightening outlook for European stocks drives outperformance against a flat US market amid fears of global trade war.

1. WHAT’S HAPPENING IN FINANCIAL MARKETS?

It was a mixed month for global markets, with US equities coming under pressure due to rising tariff uncertainty and concerns about softening consumer demand, while European stocks surged.

In a reversal of fortune, European stocks outperformed their US counterparts. European markets opened the year on a strong footing amid a wave of upbeat corporate earnings.

The outlook for Europe is also looking more positive. Fiscal spending is expected to increase as countries look to boost defence budgets to keep pace with threats facing the continent.

However, across the Atlantic, US stocks fell as America prepares to roll out its trade tariffs. US companies could see profits squeezed by a slowdown in global trade and, as a result, raise prices to offset rising costs. This could disrupt the US Federal Reserve’s (Fed) roadmap for lowering interest rates this year.

US inflation is also proving to be stickier than expected, lingering well above the Fed’s 2% target. It is likely we will see two interest rate cuts from the Fed this year, beginning in the summer. Much will depend on the strength of the labour market and the direction of inflation.

The personal consumption expenditures (PCE) price index, the Fed’s preferred inflation measure, edged down to 2.5% in January from 2.6% in December. But while it should ease concerns about inflation picking up again, it likely won’t be enough to nudge the Fed to cut interest rates in March.

Lilian Chovin, Head of Asset Allocation at Coutts, says: "Expectations were quite high for both the economic outlook and earnings, but uncertainty around trade policies has added volatility.

“Consumer confidence and inflation expectations have been impacted by noise surrounding these trade policies. US equities have dipped in response, while European markets were up in February, possibly partly because of hopes for an end to the Ukraine war, as well as positive company performance and valuation shifts."

“Expectations were quite high for both the economic outlook and earnings, but uncertainty around trade policies has added volatility.”

Lilian Chovin, Head of Asset Allocation, Coutts

2. WHAT DOES THIS MEAN FOR YOUR INVESTMENTS?

We maintain an overweight position in global equities while being underweight developed government bonds. This helped our investments withstand the recent regional stock volatility and fall in bond prices.

Our holdings take a global approach, with a particular focus on the US, where we continue to see solid economic fundamentals. Despite some disappointing corporate earnings, the broader outlook for the US remains solid. The US economy still appears to be in good shape, with company earnings expected to grow this year – just not as fast as previously thought.

Against the flow of most major economies, which are in a rate cutting cycle, the Bank of Japan raised interest rates at the end of January. This supports our recent move to increase exposure to Japanese equities, while also reinforcing our underweight stance on Japanese government bonds (JGBs).

As rates rise, bond prices typically fall, making older, lower-yielding bonds less attractive. By maintaining a lower exposure to JGBs, our funds and portfolios are less affected by this pressure, helping to potentially limit losses.

We recently adjusted our currency exposure which diversifies our holdings further. Our analysis found that the pound is undervalued versus the US dollar, so we have increased our exposure to sterling-denominated assets.

Past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can fall as well as rise and you may not get back what you put in. You should continue to hold cash for your short-term needs.

3. THIS MONTH’S SPOTLIGHT: europe makes a comeback

After years of lagging, European stocks saw their strongest performance in a decade against the US in the first couple months of the year. The surge was driven partly by the growing optimism around potential peace talks in Ukraine.

Defence spending expectations are also supporting the rally, with doubts over US security commitments prompting European governments to increase military budgets. UK Prime Minister Keir Starmer has already said that Britain would increase defence spending to 2.5% of GDP by 2027, up from the current 2.3%. Meanwhile, a new joint European borrowing effort is likely as the region seeks to ramp up military spending, which should drive bond yields higher and support growth.

The German election result has also contributed to a more positive outlook for the continent. Germany is on track to get a coalition government led by the conservative CDU/CSU alliance working alongside the Social Democrats (SPD) – with Friedrich Merz as its chancellor.

Mertz has promised to prioritise European security and wants to reduce the continent’s reliance on the US. With security set to become a key topic of discussion amid the forming of a coalition government, stocks in defence firms have received a boost.

However, European earnings could be at risk if America follows through on its proposed 25% tariff. Key European Union growth sectors, including healthcare and industrials – both major exporters to the US – face the greatest pressure.

The good news is that market conditions in Europe are steadily improving. Investor confidence in the European economy has risen sharply, with increasing optimism about growth prospects over the next year. Inflation is also anticipated to slow down at a faster pace than the rest of the world, which could give the European Central Bank greater scope to cut rates throughout 2025.