Will European Stocks Rally in 2025?
Goldman Sachs
2024-12-20Goldman Sachs Research expects European stocks to rally in 2025 even as the region faces headwinds from political and trade uncertainty and slow economic growth.
The STOXX 600 index, made up of European and UK companies, is forecast to generate a total return of about 9% next year (as of 19 November 2024) — which is modestly lower than Goldman Sachs Research’s projections for the index's US and Asian counterparts.
We sat down with Goldman Sachs Research senior strategist Sharon Bell to discuss the Europe equity strategy team’s outlook for stocks in 2025. The report, which is titled “2025 Outlook: Peer Pressure,” shows that the team slightly lowered their forecasts for the STOXX 600 for next year. At the same time, Bell points out that European stocks may benefit from cooling inflation, a larger than expected European policy response, or concerns about the prospect for returns from mega-cap US stocks.
Why did the team downgrade its STOXX 600 target prices for the next year?
We’re below consensus on growth: We’ve downgraded our economic figures and our earnings expectations for Europe in the last few months. Given all of that, we’ve also downgraded our price targets very slightly.
Europe has also seen a modest rise in risks. The stability of the fiscal situation in France, Italy, and to some extent the UK, is being questioned, for example. Economic data has been weak, and the manufacturing cycle, which particularly impacts Germany, has been really dire.
The news is not recessionary — it’s nowhere near as bad as what we saw in the financial crisis, the sovereign crisis, or the pandemic — and that’s why it’s a small downgrade. But there is undoubtedly an accumulation of risks along with weaker growth.
What sectors are you optimistic about?
We anticipate that the European Central Bank will bring interest rates down to 1.75% by the middle of next year (from 3.25% in October). Lower interest rates ought to create some opportunities in more indebted sectors like telecoms, and in areas that are sensitive to interest rates, like real estate.
We also expect consumer-facing areas — like retailers and travel companies — to be a bit more robust, because they benefit both from interest rates coming down and also from the fact that they’re not exposed to trade concerns and tariffs, because they’re catering to a more domestic consumer in Europe.
Do lower rates also benefit smaller companies rather than bigger ones?
These companies tend to be more indebted, and to have more floating debt. So interest rates coming down would help them a lot. We also expect M&A activity to pick up — we’re already seeing signs of that coming through. That also tends to help the small- and mid-sized companies, because they’re more likely targets of acquisitions.
Given rates coming down and M&A activity picking up, one would expect small- and mid-caps to do well. The only problem is that they are also cyclical — they’re very sensitive to economic growth, which remains very weak. We haven’t made a strong call for mid-caps, but I can certainly see the positive case for them at the moment.
How might exchange rates impact European stocks?
With all other things equal, lower interest rates will push down European currencies. It’s fair to say that the euro has already come down relative to the dollar, reflecting the weaker economic environment in Europe, and the stronger one that we’ve seen in the US recently.
Normally, a falling domestic currency benefits local companies, who often make some of their money outside of Europe in dollars or other currencies, and end up making more money when they convert that back into euros. This is part of the reason why companies aren’t too worried about the decline in currency — because it makes their business more competitive, for one thing.
If the euro is falling, companies with euro-area costs will also see those expenses coming down relative to companies with dollar costs. So from a competitiveness angle, the currency coming down is a good thing.
However, I don’t think it actually benefits equities overall. If you look at periods when the euro has been weak (or when sterling has been weak, in the case of the UK market), they have been associated with weaker equities. And one of the reasons is that equities are a very risk-sensitive asset. Why are currencies coming down? It’s normally either because of a risk event like a sovereign problem (as in the case of France recently), or because people are very worried about economic growth. Neither of those is likely to benefit equities.
A falling euro also discourages foreign investors from buying European equities. US investors are a large player in European stocks, and if they believe that they are going to lose on the currency fallout, then they will be put off from investing more.
In terms of economic performance, which region is most important for European companies: the US, the EU, or China?
We often ask this exact question: What matters more for Europe? We have a weak view on European growth, but we have an above consensus view on the US, and we think that China will see a stimulus that helps growth next year.
Most of European companies’ sales are to Europe. But that component — sales to Europe — hasn’t been growing at all in the last twenty years. All of European companies’ growth has come from sales to China and the US. So Europe is very reliant for its growth on those regions.
We like companies with US exposure for a couple of reasons: one is that they are exposed to a stronger economy, so over time they should get better sales and earnings; another is that they are dollar earners, by definition, and so they should benefit from a stronger dollar; and finally, in Europe, corporate taxes are generally going up, whereas in the US you may even see some taxation benefit.
The fear for these companies is that they may see higher tariffs if they’re exporters from Europe. But in the vast majority of cases, these companies are not exporters, but they have US businesses — with US assets, employees, and sales.
How do you think lower interest rates and inflation will impact European stocks?
Lower interest rates would be the most positive scenario for European companies. They stimulate better economic growth, which feeds through to better earnings. I am skeptical that that will be the case, though. I think the European Central Bank is in a cutting cycle, but a relatively cautious one — reflecting the fact that there are pockets of inflation that still look quite sticky in Europe.
That being said, because we’re below consensus on growth, we think that both growth and inflation will be a bit weaker next year. And lower inflation has historically been associated with higher valuations for the market. This is an upside we’re not totally taking into account in our target prices. We’re saying valuations will remain roughly the same over the next year, but we expect a rise in earnings. But what if we have much lower inflation, and that drives higher valuations?
Valuations can reach as much as 15- or 16-times price divided by earnings, and at the moment we’re only on 13 or 14 for Europe. So we could see a higher valuation for the European equity market, reflective of lower rates and a lower inflation environment. That’s not our core view, but it is an upside risk.
How has the strong performance of US equities impacted European stocks?
The US market has done extremely well over the last year. In fact, it has outperformed relative to Europe over any time period you choose to take, really — the last month, the last three months, the last six months, the last year, and even the last few years. And there have been a lot of fund flows into the US recently, whereas there’s not been very much allocation into Europe.
The question is: Could that reverse? We’ve had an absolutely stellar rally in the US, particularly since the election. And I think the concern is that the US looks vulnerable, given its high valuation. Could that make Europe more interesting? I’m getting a lot more questions about that.
I think Europe is an interesting market, and there are many things that could help it reverse its underperformance versus the US, but none of them are our core view: more significant policy easing, a peace deal in Ukraine, or an improvement in manufacturing in Germany, for example.
The other thing that would help Europe outperform would be something going wrong in the US in some way — either economically or with some of the largest companies. The biggest American technology companies used to be capital-light businesses, but now they’re spending a lot of money on capital investment. If people start questioning the returns on that investment, then the valuations could come down, which could benefit European stocks on a relative basis.
