Every year around this time, we get asked by journalists what level they think the market will reach in 2025. Currently, we believe that the fair value estimate for European equities has around 5% upside. By historical standards, it’s not super cheap or expensive, and compared to the premiums of global and U.S. stocks, it’s one of the best options.
Europe’s economy is improving
We are in a better position financially than we were this time last year. That is not difficult, given that the UK is in a technological recession and the eurozone is not far behind. GDP growth in both regions should be close to 1% for all of 2024, a solid improvement. The central bank expects growth to be around 1.5% in 2025, even higher than this year.
This, combined with falling inflation, is now just above the 2% target level in the euro area and the UK. In 2025, the situation is expected to remain well controlled in the absence of major external shocks. Finally, interest rates: The ECB cut deposit rates to 3% in December 2024, and it is expected that this could fall by a further 100 basis points during 2025. This means interest rates are half the levels experienced just a year ago. This will be a huge boost for European businesses and consumers.
What will Trump actually do?
Although the European economy is improving, potentially unfavorable U.S. trade policy poses a major risk to European stocks. In November, we discussed in detail the various measures that could be taken.
Ultimately, we still lack sufficient details about the planned policies, but what is clear is that maintaining a trade surplus with the United States would be tantamount to “taking American jobs.” That means Europe is unlikely to escape the president’s wrath. That said, there is a wide gap between what President Trump has promised and the changes he can make once he takes office. This is especially true regarding the Inflation Control Act, with dozens of Republicans already banding together to resist potential cuts.
Germany and France are key markets
It’s not just US politics that could be a risk factor for European stocks in 2025, but political issues closer to home are already having a negative impact. France just appointed its fourth prime minister in 2024, but his new government is struggling to agree on a budget.
In Germany, the collapse of the coalition government under Chancellor Olaf Scholz caused great uncertainty. Voters are dissatisfied and there is no clear path forward in terms of tackling the structural problems that are holding back Germany’s economy. The general election is scheduled for February 23rd
Political uncertainty will affect European stock markets in 2024, with France’s CAC40 index down nearly 3% and Germany’s DAX lagging behind the broader European market. The trend towards the populist right is evident not only in these two countries but across Europe. Nevertheless, France and Germany are the bedrock of the European economy, and further disruption in 2025 will have a negative impact on the region’s stock markets.
Impact of strong US dollar
President Donald Trump’s ‘drill baby drill’ mantra and the possibility that US interest rates could be higher than Europe’s in 2025 could mean further depreciation of the euro against the US dollar . Of course, the effects of exchange rates are neither all positive nor all negative. For European stocks with large companies based in dollar-denominated countries, a weaker euro could be a boon in terms of both translation gains and improved competitiveness.
However, there are clearly negative consequences as well, most notably increased costs for European businesses and consumers. Since the Ukraine war and sanctions on Russian gas, it has been buying large amounts of LNG imported from the United States, but if the euro weakens further against the dollar in 2025, its prices will rise.
Entering 2025 with the biggest risks in mind
A 5% rise in European stock markets could be an uphill battle. Nevertheless, things are looking up and, in relative terms, Europe remains one of the most attractive stock market opportunities heading into 2025.
The numbers also confirm the attractiveness of the opportunities in European stock markets. Sectors such as consumer cyclicals are trading at discounts of close to 25%, and the gap could narrow significantly over the course of 2025 as interest rate cuts trickle into consumers’ pockets.
The fact that we are already aware of so many big risks that we face before we enter the new year is a huge advantage, something we haven’t experienced in many years. 2020 started strong before the economy collapsed under the weight of the coronavirus. Similarly, the Ukraine war caught us completely off guard in 2022. That’s not to say we can be complacent now or that further challenges won’t emerge in 2025, but at least we have a balanced view of risk-reward trading. I am. Turn it off early.
The author owns no shares in any securities mentioned in this article. Learn about Morningstar’s editorial policy.
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