At this time of the year, we get asked by journalists what level we think markets can reach in 2025. As things stand, we see about 5% upside to our fair value estimate for European stocks. By historical standards that’s not super-cheap, nor is it expensive, and relative to the premium that global and US stocks sit on, it’s one of the best options out there.
Europe’s Economy is Improving
We’re in a better place economically than we were this time last year. That wouldn’t be hard given that the UK was in a technical recession and the eurozone was not far behind. GDP growth for both regions should be close to 1% for the full year 2024, a solid improvement. Central banks expect growth to come in at around 1.5% in 2025, another leg up from this year.
Add to this falling inflation, which now stands at just over the targeted 2% level in the eurozone and the UK. In 2025, barring a massive external shock, we would expect this to remain well under control. Finally, interest rates: the ECB cut deposit rates to 3% in December 2024, with the expectation that this could fall by a further 100 basis points over the course of 2025. This would mean rates of half the level experienced just a year ago, which would be a significant boost to companies and consumers in Europe.
What Will Trump Actually Do?
Although the European economy is improving, potentially adverse future US trade policies are a major risk to European stocks. In November, we discussed in detail the various measures that could be taken.
Ultimately we are still lacking sufficient detail on planned policies, but what is quite clear is that Europe is unlikely to escape the wrath of a president that believes that running a trade surplus with the US is akin to “stealing US jobs”. That said, there is a huge gulf between what President Trump has promised to do, and the changes he can effect once he takes office. This is especially true when it comes to the Inflation Reduction Act, where dozens of Republican members of Congress have already come together to resist potential cuts.
Germany and France are Key for Markets
It’s not just US politics that could be a risk factor for European equities in 2025, political issues much closer to home are already having a negative impact. France just named its fourth Prime Minister of 2024, and his fresh administration is struggling to agree on a budget.
In Germany, the collapse of the coalition under Chancellor Olaf Scholz has caused huge uncertainty. Voters are unhappy, and there is no clear path to progress in terms of tackling structural issues that are holding back the German economy. The general election is set for Feb. 23
Political uncertainty has dragged on European equity markets in 2024, with France’s CAC 40 benchmark down nearly 3% and the German DAX also lagging the broader European market. The lurch to the populist right has been evident not only in these two countries, but across Europe generally. Nonetheless, France and Germany are the bedrock of the European economy and any further turbulence in 2025 will have a negative effect on the region’s equity markets.
Impact of a Stronger US Dollar
Donald Trump’s “drill baby drill” mantra and the likelihood of higher US interest rates than in Europe in 2025 could mean further depreciation of the euro against the US dollar. Of course, the effect of exchange rates is never all positive or all negative. For European stocks with large businesses in dollar-denominated countries, a cheaper euro could be a boon, both in terms of translation gains and increased competitiveness.
But there are clearly negative implications too, most notably higher costs for European businesses and consumers. Since the Ukraine war and the sanctions placed on Russian gas, we have been buying large quantities of US-imported LNG, the cost of which will increase if the euro falls further against the dollar in 2025.
Entering 2025 With Most Risks in View
That 5% upside in European equity markets could be hard fought. Nevertheless, upside is upside, and on a relative basis Europe remains one of the most attractive equity market opportunities for 2025.
The figure also belies the attractiveness of the opportunities within European equity markets. Sectors like consumer cyclicals are trading at discounts of close to 25%, a gap which could be narrowed markedly over the course of 2025 as interest rate reductions filter down to consumers' pockets.
The fact that we are already aware of so many large risks facing us before we even enter the new year is a huge advantage, and one we haven’t had in many years. 2020 began strongly, before the economy collapsed under the weight of covid. Likewise, the Ukraine war caught us completely off-guard in 2022. That’s not to say we can now be complacent, or that more challenges won’t appear in 2025, but at least we have a balanced view of the risk/reward trade-off ahead of time.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
