Is ‘unfashionable’ market now a place for investors to shop?

What have investors got against European stock markets? Prior to the turmoil of the past few weeks, Europe was posting some of the most impressive returns of all stock markets in developed economies. Yet investors in the UK appear to have been largely unmoved.

Over the year to the end of March, European stock markets, as measured by the MSCI Europe (ex UK) index, delivered a return of 5.6%; the US did better, with a return of 8.2% over the same period, but much of that performance came from the “Magnificent Seven” technology stocks, where concern about valuations continued to mount up.

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Several individual European markets delivered particularly eye-catching gains. Spain and Germany were up 25.1% and 19.0% respectively over the 12 months to the end of March, with Switzerland also performing strongly. And while French equities were broadly flat over this period, that reflected a sharp sell-off in the second half of 2024, following the market’s peak in March. Between November and March this year, French equities then posted gains of around 10%.

Unloved region

Despite these attractive returns, investors in the UK have continued to look elsewhere. In February, the most recent month for which the Investment Management Association has published data, retail investors sold £364 million more of Europe (excluding UK) funds than they bought. US funds, by contrast, registered positive sales of £415 million over the same period.

Nor does Europe appear to have captured the imagination of investors using their ISA allowances in recent months. Ongoing concern about war in Ukraine may be part of the story, particularly given President Zelensky’s ill-fated visit to the White House, but another factor at play is that many investors just struggle to get excited about European equities.

“Europe is often seen as an unfashionable and slightly dull market with old economy stocks,” says Ben Yearsley, an investment consultant at Fairview Investing. “The thing is that many of those stocks – and banks especially – have done exceptionally well over the last year or so.”

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Alex Watts, a senior investment analyst at interactive investor, agrees. “Some sectors have showed especially notable strength,” he says. “Over the year to end of March 2025, European financials returned close to 29%, with banks posting strong earnings and returning capital via dividends and buybacks. European defence companies returned an impressive 31% as the US ratcheted up demands for Europe to increase defence spending.”

Time to reconsider?

So, is it time for investors in the UK to reconsider their lack of interest in continental European equities? After all, valuations in the markets of our near neighbours looked cheap by global comparisons even before President Trump threw the world into chaos with his global trade tariffs announcements.

In practice, both Yearsley and Watts are cautious about what lies ahead. It’s not just that the European Union still has to resolve its differences with the Trump administration; higher trade tariffs may be on pause for now, but remain a possibility, with serious implications for the economy of the bloc and for the earnings of many of its largest companies. Other challenges also loom large, including the ongoing Ukraine conflict.

“With volatility in energy prices and the dependence on Russia still not really resolved, Europe isn't in the best spot,” Yearsley warns. “Add in the need for increased defence spending, which will either lead to tax hikes or more borrowing, and the outlook is lacklustre.”

The European Central Bank does appear to be open to providing support; it has already cut interest rates six times since last June and is expected to loosen policy further in the wake of President Trump’s trade bombshells.

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Still, Watts adds: “While broadly weaker valuations in Europe versus the US provide some opportunity for valuation-minded and dividend-focused investors, the outlook varies enormously by country and by sector given the volatile macro picture; that warrants a careful and thorough attitude to allocating within the region.”

Outlooks from the pros

Fund managers specialising in European stocks don’t disagree – but they do believe it will be possible to pick a winning path through the current volatility and uncertainty.

“We believe the prospective returns from Europe are still OK,” says Philip Wolstencroft, who has managed the Artemis SmartGARP European Equity fund since its launch in 2001.

He adds: “It’s worth remembering that the tariffs are on trade with the US, which represents around 25% of the world economy, so this is important, but it’s not the whole world. Meanwhile, inflation isn’t a major problem globally, so interest rates and bond yields are probably heading sideways or downwards.”

Wolstencroft accepts there are risks to corporate earnings but points out that some sectors still look healthy. “Banks are still cheap compared to the market, and their earnings per share are growing faster than the market,” he says. “During the past three months there have been more and greater upgrades in banking than in any other sector. Consequently, we see little reason to change our broad positioning.”

David Walton, manager of the IFSL Marlborough European Special Situations fund, a smaller companies specialist, points out that “there are always opportunities to be found on a business-by-business basis”.

He adds that smaller businesses tend to be more domestically focused, and therefore less exposed to tariffs. “Many of these companies face little or no competition – either from within Europe or from the US,” says Walton.

Simon Edelsten, chief investment officer and fund manager at Goshawk Asset Management, is looking for similar opportunities. Valuations remain attractive in Europe, he reiterates, particularly in comparison to US technology stocks, and spending in countries such as Germany on defence and infrastructure could drive continued outperformance from some sectors.

“Most European equity markets contain a number of medium-sized companies that are successful within Europe and will be less affected by tariffs,” Edelsten adds.

“Also, many financials fall outside the tariff regime. The prospects for these companies look fair if the EU ends up trading more openly with itself and not so much with the US.”

Daniel Lockyer, senior fund manager at Hawksmoor Investment Management, is also optimistic – particularly about Germany.

He says: “There are a number of reasons why Germany is outperforming global indices, including the recent easing of the debt brake to release hundreds of billions of euros into the economy to invest in infrastructure, green energy and defence.

“Despite this easing, Germany’s debt to GDP ratio remains one of the best in the developed world so policymakers had scope to do this.”

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Lockyer also points to the upside case for European equities more broadly. “Europe offers opportunities for actively managed funds due to the high levels of dispersion within the market,” he argues.

“Europe should also benefit from peak American exceptionalism as global asset allocators ponder where else to allocate money if there are doubts over the US market no longer being a one-way bet.”

For investors convinced by these arguments – and ready to put recent antipathy to Europe behind them – there are a variety of different options.  

“The Artemis SmartGARP European Equity fund stands out for its disciplined, value-driven process and long-term outperformance,” says Scott Gallacher, a chartered financial planner and director at independent financial adviser Rowley Turton. “For those looking for low-cost, broad exposure to eurozone blue-chips, the Xtrackers Euro Stoxx 50 ETF 1C GBP (LSE:XESC) is a solid option.”

Yearsley, meanwhile, picks out Montanaro European Smaller Ord (LSE:MTE), which could appeal to investors looking for more domestic exposure – and less risk from Trump’s tariffs. Alternatively, he also recommends Fidelity European and its investment trust sister fund Fidelity European Trust Ord (LSE:FEV).

As for interactive investor’s own analysts, Alex Watts is a fan of BlackRock Continental European Income, which is included on ii’s Super 60 list of investment ideas.

“The fund holds a flexible, high-conviction portfolio of large, well-established European businesses,” Watts explains. “It is currently yielding 3.9% and has historically beaten the yield of the benchmark by 50%. In volatile times especially, the distribution of a consistent yield can offer some buffer against downwards moves in the market.”