European stocks have surged in the first half. How will they perform for the rest of 2025?

European shares significantly outperformed US equities in the first half of the year, with the pan-European Stoxx 600 gaining 7% compared to the S&P 500's approximately 5%, prompting a divided outlook for the second half. Firms like Goldman Sachs Asset Management and RBC Wealth Management are bullish, citing appealing fundamentals, diversification from US assets, and emerging opportunities in defense and financials driven by fiscal reforms and attractive valuations. Conversely, Mercer and Bank of America express caution, pointing to softening economic fundamentals, potential tariff impacts, stretched valuations, and a projected 10% downside for the Stoxx 600, advocating for a more neutral or cautious stance on European equities.

Analysis

European equities delivered significant outperformance relative to U.S. markets in the first half of the year, with Germany's DAX surging 20% and the pan-European Stoxx 600 gaining 7%, compared to a 5% rise in the S&P 500. However, institutional outlook for the second half is sharply divided. Bullish arguments from Goldman Sachs Asset Management and RBC Wealth Management highlight structural improvements, including German fiscal reform and increased NATO defense spending, which are creating opportunities in defense, energy, and infrastructure. They also note that European equities, trading at a discount to the U.S. on a sector-adjusted basis (MSCI EMU at 15.4x forward P/E), offer compelling diversification. Conversely, a more cautious stance is advocated by Mercer and Bank of America. Mercer cites softening economic data, cooling labor markets, and the delayed impact of tariffs as reasons for caution, recommending neutrality between European and U.S. equities and favoring fixed income. Bank of America is explicitly bearish, forecasting a 10% downside for the Stoxx 600 due to tariff-related pressures on global growth and has downgraded the outperforming utilities sector from overweight to marketweight.

Key Decisions for Investors

• Investors with a constructive view on European fiscal stimulus should consider overweighting sectors like defense, specific industrials, and financials, which are highlighted by bullish analysts as direct beneficiaries.
• Given the explicit warnings from Bank of America about a potential 10% downside in the Stoxx 600, holders of broad European equity positions should review their risk exposure and consider hedging strategies.
• For those cautious on equity valuations but still positive on the region's narrative, consider alternative expressions such as a long euro versus dollar position, a strategy recommended by Mercer.
• Re-evaluate positions in European utilities, as the sector's 24% outperformance since February has prompted a downgrade from Bank of America on concerns that prices have overshot their fundamental drivers.