European share gains to be kept in check by Trump tariffs

A Reuters poll projects modest year-end gains for European equities, with the STOXX 600 expected to rise 3% to 570 points, primarily supported by looser fiscal and monetary policies but constrained by the ongoing impact of U.S. import tariffs on corporate earnings. While European shares initially outperformed, U.S. markets have largely caught up, yet European equities remain significantly undervalued, trading at a 36% discount to the S&P 500, suggesting continued, albeit limited, upside potential for investors focused on relative value.

Analysis

The consensus outlook for European equities suggests modest gains through year-end, constrained by a clear tension between supportive policy and trade-related headwinds. A Reuters poll forecasts the pan-European STOXX 600 will rise approximately 3% to 570 points, supported by looser fiscal and monetary conditions. However, this upside is capped by the anticipated impact of a 15% U.S. import tariff, which is expected to fully filter into corporate earnings during the second half of the year. While European companies demonstrated resilience with five consecutive quarters of earnings growth, the early-year outperformance of European shares has diminished as U.S. indices, powered by sustained AI-related capital spending from tech giants like Microsoft and Meta, have caught up. The core bullish thesis for Europe now rests on a compelling valuation argument; the STOXX 600 trades at a 36% discount to the S&P 500 on a 12-month forward earnings basis, a level near its historical record. This valuation gap underpins a strategic preference for the region from institutions like Deutsche Bank and Barclays, with the latter anticipating a broadening of the rally into lagging cyclical and exporter stocks.

Key Decisions for Investors

• Given the significant 36% valuation discount to U.S. equities, investors should consider maintaining strategic allocations to broad European indices, as this relative cheapness provides a potential cushion and long-term upside.
• Monitor upcoming H2 corporate earnings reports closely for the realized impact of U.S. tariffs, as downside surprises could challenge the consensus forecast for modest growth.
• Consider rotating into undervalued European cyclical and exporter stocks that have lagged the recent rally, which, as Barclays suggests, could benefit from converging EU-U.S. growth dynamics.
• Recognize that with a consensus forecast of only low single-digit upside, the risk/reward for aggressive new tactical positions may be limited, warranting a cautious approach to adding exposure at current levels.