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On Tuesday, European stock markets snapped a three-day losing streak following news that US President Donald Trump may soften his tariff stance. The pan-euro Stoxx 600 index rose 0.67%, the DAX jumped 1.13%, and the CAC 40 climbed 1.08%.  

In the year to date, Europe’s equity markets continue outperforming their US counterparts, with the euro Stoxx 600 gaining 8.9% and Germany’s DAX up 16%, while the S&P 500 is down 3% and the Nasdaq fell 5.4%.  

Relatively cheaper valuations, expectations for surging defence spending, and more accommodative monetary policies may have all contributed to the rally in European markets this year. A possible permanent ceasefire in the Ukraine war has also provided optimism toward Europe’s economic outlook. Goldman Sachs analysts expect European equities to continue the uptrend with a 5-6% upside for a 12-month target.

The recent economic data points to upside potential for the block’s economic growth. On Monday, S&P Global released better-than-expected flash manufacturing Purchasing Manager Indexes (PMIs) for major economies. While the data remained in contraction, the decline in Germany was the mildest since September 2022. “Some firms attributed this rise to stronger domestic demand and clients replenishing stocks,” the report stated.

On the other hand, Trump’s tariffs and his efforts to reduce the US deficit led to growing uncertainties about the country’s economic outlook, which, in turn, hurt equity valuations, particularly in the well-known tech stocks. On Tuesday, data from the Conference Board showed that the US consumer expectations tumbled to the lowest level in 12 years.  

Banking stocks shine

Europe’s financial sector was the top performer in the euro Stoxx 600 Index, up 23% in the past three months. In 2024, the banking sector gained 25%, compared with the Stoxx 600’s 5% rally. Robust earnings results, generous dividends, and share buyback programmes have all contributed to the sector’s outperformance.

Eurozone’s major banking stocks, including Banco Santander, BNP Paribas, and Intesa Sanpaolo, all hit all-time highs on Tuesday. Particularly, the Spanish lender Santander’s share surged 49% this year, becoming the first Eurozone bank topping a €100 billion market capitalisation, alongside Switzerland’s UBS and the UK-based HSBC. BNP Paribas experienced a 37% year-to-date rally, with a capitalisation of €92bn. Shares of Italy’s biggest lender, Intesa Sanpaolo, also jumped 2.8% on Tuesday and gained 28% this year, making it the third-biggest bank in the EU, with a market valuation of €88bn.  

Industrial sector outperforms as defence stocks soar

The European industrial sector gained 16% in the last three months, making it the second-best performer. The sector’s gains were primarily driven by defence stocks as the EU plans to boost defence spending. Germany’s historical debt reform is set to unlock hundreds of billions of euros to invest in defence and infrastructure. Industrial stocks, seen as a typical cyclical sector relating to economic growth, comprising of aerospace/defence companies and major energy firms, are expected to be the biggest beneficiary of increased fiscal spending.  

Germany’s ammunition manufacturer Rheinmetall’s stocks soared more than 100% this year, and France’s Thales SA surged 80% this year. Other stocks in this group, including British firms, such as BAE Systems and Rolls Royce Holdings, were both up by 36% year-to-date.  

Risks remain

However, risks remain in the European markets. Trump’s tariffs are expected to impact the global economy as a whole due to trade barriers. Central banks, including the European Central Bank, foresee higher inflation and slower economic growth. The economic dynamics will likely slow the pace of the easing cycle, which could restrain business growth. All major European firms are exposed to global markets, with some owning US divisions. Hence, a global trade war will certainly ripple through European markets and hurt sentiment.