6 Factors to Play Europe ETFs Now

Several investment banks, including JPMorgan, Citi, and UBS, anticipate European equities will significantly outperform U.S. equities, potentially by the widest margin in over 20 years, driven by cooling European inflation (Euro zone inflation fell to 1.9% in May) and anticipated ECB rate cuts. In contrast, the OECD downgraded U.S. growth forecasts to 1.6% for this year and 1.5% for 2026, citing tariffs and policy uncertainty, while China's manufacturing activity contracted; additionally, European equities show more attractive valuations, with the Vanguard FTSE Europe ETF (VGK) having a P/E ratio of 12.26X compared to the Vanguard S&P 500 ETF (VOO) at 24.72X.

Analysis

Wall Street strategists, including those at JPMorgan, Citi, and UBS, are increasingly forecasting European equities to significantly outperform U.S. counterparts, potentially by the widest margin in over two decades. This outlook is underpinned by several converging factors: Europe's cooling inflation, with the Eurozone rate unexpectedly falling to 1.9% in May, below the European Central Bank’s (ECB) 2% target. This was accompanied by a steep drop in services inflation from 4% to 3.2% and a decline in core inflation to 2.3%, bolstering confidence in Europe's economic stability. This disinflationary trend supports a more accommodative ECB, which has already initiated rate cuts, lowering the deposit facility rate to 2.25% from 4% in mid-2023, with further easing anticipated. In contrast, U.S. inflation is projected by the Organisation for Economic Co-operation and Development (OECD) to approach 4% towards the end of 2025. European equities also present more attractive valuations; the Vanguard FTSE Europe ETF (VGK) trades at a P/E ratio of 12.26X, substantially lower than the Vanguard S&P 500 ETF's (VOO) 24.72X, and Europe's sector-adjusted P/E is currently 18% below that of the U.S., a gap historically seen during recessions or significant crises. Furthermore, UBS highlights improving relative earnings momentum in Europe, aided by a weaker euro and rising Purchasing Managers' Indexes (PMIs), with European companies (excluding financials) reportedly having healthier and more sustainable profit margins than their U.S. counterparts. The HCOB euro zone manufacturing PMI also showed improvement, confirmed at 49.4 in May 2025, rising from 49.0 in April and marking the slowest rate of contraction in the manufacturing sector since August 2022, with output increasing for the third consecutive month. This positive European backdrop contrasts with a downgraded U.S. growth forecast by the OECD (to 1.6% for the current year and 1.5% for 2026) attributed to tariffs and policy uncertainty, alongside contracting manufacturing activity in China. Recent performance reflects this shifting sentiment, with European ETFs such as the Select STOXX Europe Aerospace & Defense ETF (EUAD, up 10.6%) and the First Trust Europe AlphaDEX Fund (FEP, up 7.4%) outperforming the SPDR S&P 500 ETF Trust (SPY, up 5.9%) over the past month.

Key Decisions for Investors

• Investors should consider increasing strategic allocations to European equities, given the confluence of attractive valuations, supportive monetary policy divergence from the U.S., and improving earnings momentum.
• Closely monitor upcoming European Central Bank policy decisions and inflation data releases in the Eurozone, as these will be critical catalysts for the region's equity market performance.
• Evaluate specific European sector or thematic ETFs, such as those demonstrating recent outperformance like EUAD (aerospace & defense) and FEP (alpha-seeking), or broad market ETFs like VGK, to capitalize on the anticipated regional outperformance.
• Exercise caution regarding U.S. equity allocations due to projected slower economic growth, persistent inflation concerns identified by the OECD, and potential policy-driven headwinds, thereby considering relative value opportunities that may favor Europe.