Deutsche Bank upgrades Europe to positive versus the U.S. Here's why

Deutsche Bank has upgraded its stance on European equities from neutral to positive, forecasting an end to 15 years of underperformance against the U.S. The bank expects further upside until year-end, citing cheaper valuations, higher diversification, and a strong fiscal impulse, projecting up to 16% gains across major European indices by 2026 and 12% earnings growth for the Stoxx 600. UBS concurs, forecasting 10% annualized returns for the Stoxx 600, as investors seek opportunities outside potentially inflated U.S. valuations and concentration risks, highlighting Europe's undemanding valuations, particularly in small and mid-cap segments.

Analysis

Deutsche Bank has upgraded its stance on European equities from neutral to positive, anticipating an end to 15 years of underperformance against the U.S. The bank projects further upside until year-end, citing "cheaper valuations, higher diversification, and a strong fiscal impulse." This follows a July downgrade, with DB now forecasting up to 16% gains across major European indices by 2026 and 12% earnings growth for the Stoxx 600. UBS also concurs, forecasting 10% annualized returns for the Stoxx 600.

European valuations are noted as "undemanding" compared to their own history, particularly in the Small and Mid Cap space, contrasting with inflated U.S. valuations and mounting AI bubble concerns. The Stoxx 600 is up almost 11% year-to-date, while Germany's DAX and France's CAC 40 are up nearly 22% and 7.5% respectively. This valuation discrepancy, coupled with lower concentration risk in Europe (Stoxx 600 top members account for 14% vs. S&P 500's third), presents a compelling case.

Key drivers include a strong fiscal impulse, exemplified by Germany's 2025 budget approval and increased defense spending, which will benefit European manufacturers. While short-term political volatility in France is acknowledged, global economics are expected to be a greater influence on French stocks, with DB seeing 14% upside for the CAC by end 2026. European exit markets are also picking up, with Sweden experiencing an IPO boom.

Deutsche Bank believes an inflection point has been reached, shifting from the structural outperformance of US equities. Underlying shifts in valuations, debt levels, market concentration, and risk profiles are paving the way for a potential resurgence in European equity appeal.

Key Decisions for Investors

• Investors should consider increasing exposure to European equities, particularly in small and mid-cap segments, given undemanding valuations and projected earnings growth.
• Monitor fiscal policy developments and defense spending in key European economies like Germany, as these provide a positive demand impulse for local manufacturers.
• Evaluate European equity funds or ETFs as a diversification strategy against potential overvaluation and concentration risks in the U.S. market, while acknowledging short-term political risks in specific regions.