European equities, which have enjoyed substantial gains over the past two years, are now grappling with diminished momentum. Concerns about slowing economic growth and ongoing tensions with China are compounding investor unease, leaving the region’s stock market vulnerable.
Luxury brands like LVMH Moët Hennessy Louis Vuitton SE and major automotive firms have seen their stocks decline over the past six months. More recently, healthcare giants such as Novo Nordisk A/S and tech leaders including ASML Holding NV have also fallen from their recent highs. The absence of strong new leaders to drive market performance has exposed European equities to increased risk.
In stark contrast to the influx of capital into US and international equity funds, European-focused funds and ETFs have seen substantial withdrawals this year. The primary issue lies in the waning influence of Europe’s key growth drivers compared to the dominant American technology sector, often referred to as the “Magnificent Seven.”
Ariane Hayate, a fund manager at Edmond de Rothschild Asset Management, highlighted the shifting dynamics: “Leadership is changing in the European market. Smaller and more defensive sectors are now leading the pack.”
Europe’s stock market is inherently more cyclical compared to its US counterpart, with economically-sensitive sectors comprising roughly two-thirds of the benchmark Stoxx 600 index. As such, the index’s performance is closely tied to these sectors. However, the combined impact of slowing growth and trade uncertainties with China poses a significant threat to this support.
Ajay Rajadhyaksha, a strategist at Barclays Plc, noted that many European companies derive a substantial portion of their revenue from the US and China. “If global trade war risks escalate, it is easy to see these companies’ valuations being negatively impacted,” he said.
European firms are particularly sensitive to Chinese demand, with approximately 8% of their revenues coming from China, compared to only 2% for their S&P 500 counterparts. This dependency is compounded by Europe’s planned additional tariffs on Chinese electric vehicles and the broader economic impact of China’s slowdown, including plummeting oil prices that are affecting Europe’s energy sector.
In the US, Big Tech companies have significantly driven market performance, with six of them featured among the top ten contributors to major indexes, accounting for over 50% of returns. Conversely, in Europe, the health care sector, along with consumer staples firm Unilever Plc, has been a key contributor, but these sectors’ defensive nature may not match the explosive growth seen in cyclical industries like luxury goods.
Despite relatively stable earnings forecasts for 2025, Barclays’ Rajadhyaksha anticipates that data surprises could negatively impact profit estimates. A Citigroup Inc. index measuring earnings revisions has shown a negative trend throughout the summer.
As previous market leaders lose their edge, investors are actively seeking new opportunities. Gilles Guibout, a portfolio manager at Axa Investment Managers, sees potential in sectors like banks and utilities. European banks, which have surged 18% this year, are expected to continue benefiting from low valuations and rising dividends. Similarly, utilities are starting to outperform due to lower interest rates and promising dividend yields.
Looking ahead, other fund managers believe that if the economy manages a soft landing, there could be a shift towards smaller and mid-cap stocks. Amelie Derambure, a senior multi-asset portfolio manager at Amundi in Paris, suggested that “betting on the broadening of the rally, particularly among laggards, could be advantageous if economic growth rebounds.”
In summary, the European stock market faces a critical juncture as it navigates diminished growth drivers and shifting sector dynamics. Investors are closely monitoring the evolving landscape for potential new leaders to drive future performance.
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