(Photo by THIERRY CHARLIER / AFP) (Photo by THIERRY CHARLIER/AFP via Getty Images)
U.S. stocks stumbled into the end of the first quarter, with the S&P 500 sliding 5.1% and finishing 3.1% below its 200-day moving average. The post-election optimism that excited markets late last year has given way to unease as investors confront rising policy uncertainty and new geopolitical risks. However, despite the market turmoil in America, some regions of the world oddly benefit from the Trump administration’s change in geopolitical strategy. Europe, after years of stock market irrelevance, is finally starting to shine.
European equities just delivered their strongest quarterly performance in decades, outperforming the S&P 500 by 18.4% in dollar terms, the widest margin in over 30 years. The outperformance comes as a surprise to many, especially given Mario Draghi’s downbeat assessment of European competitiveness just six months ago. What has changed?
MSCI Europe quarterly return relative to MSCI USA
Germany’s Fiscal Stimulus Marks A Turning Point For The Eurozone
Valuation is one reason behind the rally. European stocks, which have traded at a discount to U.S. equities for more than a decade, look attractive to global investors in search of value. As of March 30, the MSCI Europe Index trades at a forward P/E ratio of just 14.6x, compared to the S&P 500’s 20.8x. That kind of valuation gap provides a point of refuge for investors concerned about the relatively high multiples in the growth-oriented S&P 500.
But valuation alone didn’t spark the rally. Germany’s pivot toward aggressive fiscal stimulus, triggered by the United States desire to step back from its traditional role as the global security guarantor, has boosted the region’s outlook for spending and growth.
Germany’s new fiscal initiatives include a €500 billion infrastructure investment fund and an exemption from the constitutional debt brake for defense spending. This fiscal impulse is anticipated to widen Germany’s deficit and revive economic growth. Fitch Ratings projects that the deficit could increase to between 4% and 4.5% of gross domestic product by 2027, up from 2.6% in 2024.
The policy shift is creating hope that the era of lackluster GDP growth for European economies may finally be over. “In more than 30 years in markets, I’ve rarely seen such a sharp turn in Euro-optimism,” Holger Schmieding, chief economist at Berenberg, told Bloomberg.
Investor Rotation: Why Money Is Flowing From The U.S. To Europe
While the positive catalysts in Europe are strong, much of the recent strong relative performance stems from weakness in the United States. President Trump’s tariff policy, along with the potential for higher consumer prices and an economic slowdown, has reignited stagflation fears.
In anticipation of slower U.S. economic and corporate profit growth, investors are shifting out of high-momentum names like Nvidia and Tesla and toward defensive, lower-valuation segments of the market. That plays to Europe’s strengths, as its stock indexes tend to be more heavily weighted toward value-oriented sectors.
The strength of the euro reinforces the shift. The currency has rallied from 1.024 in February to nearly 1.082 by late March. U.S. dollar investors buying European equities could get an added benefit from a strengthening euro.
Sector Winners In Europe: Defense, Banks, And Infrastructure
Defense stocks have led the indexes higher. Germany’s Rheinmetall AG has seen massive gains, fueled by expectations of long-term rearmament across Europe. Thyssenkrupp AG, historically known for steel and industrial manufacturing, has also rallied as investors bet on infrastructure modernization and potential reconstruction efforts in Ukraine. Rheinmetall has surged 113% in 2025, and Thyssenkrupp has jumped 130% in the last three months.
Outside of Germany, stock markets in other countries are doing even better. While EWG, the iShares MSCI Germany ETF, has risen 17.5% in Q1 2025, GREK, the Global X MSCI Greece ETF, has jumped 25% in Q1 2025. EWP, the iShares MSCI Spain ETF, has climbed 23.7%.
European ETFs have outperformed the U.S. market so far in 2025.
Banks and insurance companies have also been among the top performers in the Euro Stoxx 600. Rising interest rates due to the anticipated increase in supply from additional government spending have lifted financial stocks.
Can Europe Sustain Its Market Momentum?
Despite the optimism, Europe faces structural hurdles. As the Draghi report highlighted, its capital markets remain fragmented and onerous regulations inhibit innovation. Furthermore, there is no evidence yet that corporate earnings will mirror the advance in share prices. Finally, let’s not forget China, whose economic uncertainty could be an issue for Europe’s export-heavy economy.
Still, Europe’s rally is real and broadening. But sustaining the outperformance will require more than attractive valuations and reactive flows out of the United States. The region must deliver on promised fiscal stimulus, manage growing geopolitical risk, and navigate a potential trade war before investors can be confident in the rally’s durability.
For now, investors are betting the momentum can continue. The payoff will depend as much on Washington as on Brussels or Berlin.
