European equity markets have taken off in 2025, outpacing their American counterparts and surprising investors. Despite an early rally, Goldman Sachs Research still sees room for another 6% gain over the next year. Strong corporate earnings, increased defense spending, and the absence of new US tariffs on European goods have fuelled the momentum. As sentiment shifts and valuations rise, investors are left wondering—how much higher can European stocks climb?
Investor skepticism at the start of the year set the stage for a strong performance. With fears over economic stagnation, potential US tariffs, and sluggish growth, European markets had been undervalued. However, key policy shifts, particularly Germany’s move to increase infrastructure and defense spending, have reshaped expectations. This fiscal push, coupled with solid corporate earnings, has provided the catalyst for Europe’s stock market resurgence.
The valuation gap between the US and Europe has narrowed but remains significant. US equities began the year at historically high valuations, while European stocks, after a 10-12% rally, are now positioned above the 50th percentile. Yet, despite the recent climb, Goldman Sachs Research sees additional upside, forecasting a further 5-6% rise in the next 12 months. While the pace of growth may slow, Europe’s improving economic outlook, particularly in Germany, suggests that the market still holds potential for medium-term gains.
A key factor in Europe’s continued strength will be its response to US economic conditions. Signs of a slowdown in the US economy could impact European equities, particularly companies with significant US exposure. However, with US interest rates providing flexibility for stimulus if needed, a moderate soft patch in US growth is unlikely to derail Europe’s momentum.
Sector-wise, defense stocks have been standout performers, surging 67% since the start of the year. While valuation risks remain, continued geopolitical tensions suggest ongoing demand for defense spending. Beyond defense, healthcare appears well-positioned, offering stable growth potential at reasonable valuations. The telecoms sector is also gaining attention, with potential regulatory changes providing pricing power to European firms. Meanwhile, banks stand to benefit from improved European growth and higher long-term interest rates, while infrastructure-focused companies are set to capitalise on increased fiscal spending.
The broader question remains—can Europe sustain its outperformance over the US? Goldman Sachs Research remains neutral in its US vs. Europe allocation, favouring diversification over a singular bet. However, Europe’s ability to continue its resurgence hinges on key structural changes: boosting infrastructure, lowering energy costs, and maintaining fiscal support. With energy prices still a major burden on European industry, solutions such as renewable expansion and increased gas imports could provide long-term relief. By 2027, new energy supplies from Qatar and the US may further support Europe’s competitive position.
For now, European equities remain an attractive opportunity for investors seeking growth. With shifting sentiment, improved government spending, and stabilising valuations, the rally may still have further to run.
Fidelity European Trust PLC (LON:FEV) aims to be the cornerstone long-term investment of choice for those seeking European exposure across market cycles.
