European stocks’ comeback

Good morning. Bullet dodged: Nvidia’s earnings and guidance were sufficiently ahead of Wall Street’s estimates to keep the stock flat in late trading yesterday. So catch your breath and think back to the DeepSeek panic of a month ago. The market — and Unhedged — wondered if the Chinese AI company’s low-cost model might end the Big Tech money fight, of which Nvidia is the prime beneficiary. Looking back, this speculation was premature. Microsoft, Meta, Google, Amazon, et al are huge battleships that turn slowly. Adjusting their capital expenditure plans is not like turning a spigot. It is the nature of markets (and market writers) to overreact to exciting news. Send us calming thoughts: robert.armstrong@ft.com and aiden.reiter@ft.com. 

Europe’s outperformance 

European stocks are outperforming their US counterparts this year, and the punditocracy is excited. Given the new US president’s economic hostility to the continent — evidenced most recently by his latest tariff announcement — outperformance is the opposite of what one might have expected to happen.

Is this an inflection point or a blip? US assets ever-widening valuation premium has been a topic of debate for years. Perhaps mean reversion has finally arrived. On the other hand, it’s been a pretty weird year, so it might be a mistake to read too much into the market action. 

One way to think about this is in terms of sectors. The consensus explanation of Europe’s long-term underperformance (which dates back about 15 years) is that European indices are full of old-economy value stocks — banks, industrials, miners — and value has underperformed growth, and specifically tech, for a long time.

But this is not quite right. Looking at sector performance back to 2011, the US has massively outperformed Europe in every sector except energy, where the performance is similar. This very much includes value sectors such as materials, staples and industrials.

But Europe’s catch-up did not start this year. For the previous two years, while European big caps did underperform badly at the index level, Europe either outperformed the US or was within a few percentage points of it in financials, industrials, real estate, energy, utilities, healthcare and materials.

The only areas of spectacular US outperformance since 2023 have been the sectors dominated by the Magnificent Seven tech stocks (technology, consumer discretionary and communications) and consumer staples. 

So what we are seeing this year is not that surprising on the European side (although many of Europe’s largest companies, from SAP to LVMH to Deutsche Telekom, have had a strong start to 2025). The big change is on the US side, as the unstoppable Mag 7 have fallen. 

If this is right and you suspect (as I do) that the Mag 7’s immense growth potential is mostly priced in, it makes sense to think that Europe’s improved relative performance might persist — at least until the next great American tech stock comes along. 

(Consumer staples stocks are the exception to this general point. Walmart and Costco, which have performed brilliantly lately, dominate US staples indices. Why Europe doesn’t have equivalent retail champions, I’m not sure — is it, à la Mario Draghi, the lack of a truly unified internal market?) 

European defence stocks

One of the things working in Europe is defence stocks. Earlier this month, American leaders insisted that Europe (including the UK) would need to pay more for its own defence, as the US focuses on other priorities. At the same time, Donald Trump has demonstrated his indifference to European security concerns by negotiating directly with Vladimir Putin.

Stocks of the biggest European defence companies (blue) jumped, while US players (red) remained flat to down throughout February:

This makes sense. Europe’s goal is not just to be better armed, but also more capable at arming itself — especially if the US is no longer a reliable partner. This suggests that European defence stocks may be a secular growth story.

In truth, they have been for a while now. Since the start of Russia’s war in Ukraine, European defence stocks, specifically Thales, Leonardo and BAE, have mostly flourished, as a multi-country defence spending cycle got under way. Recent US threats just add fuel:

So is the European industry’s gain a loss for US defence companies?

Probably not in the short term. But in the longer term, Europe has capacity to replace a lot of its US arms imports. According to Loredana Muharremi at Morningstar, the uptick in spending will be gradual — she does not expect European defence spending to cross 3 per cent of GDP until 2029 (it is around 1.9 per cent right now). But when that time comes, bigger European countries can fill some of the void. From Muharremi:

US [arms] imports are more than half of Europe’s overall arms imports. But if you look at the big spenders (Germany, Italy, UK, Spain and Poland), it’s less than 8 per cent. Those countries already have bigger defence industries, and have the [potential] to replace US imports for the smaller players.

At the same time, though European purchases of US arms have increased since the war in Ukraine, Europe remains a rather small share of US defence companies’ revenue — less than 8 per cent of the total 2024 revenues of General Dynamics, Lockheed Martin, RTX and Northrop Grumman. And Europe is not expected to shift away from the US entirely. From Pierre Chao, a longtime defence analyst, currently at Renaissance Strategic Advisors and Proteus Capital: 

I’m not sure that Europe would ever look to [replace all US defence imports]. There are certain exquisite capabilities that the US has that would not make sense to build on your own, unless you think there is a full and permanent rupture.

US defence companies’ bigger worry is domestic demand. Newly minted secretary of defence Pete Hegseth is looking to cut the DoD’s budget. And without a war in Ukraine, the US will no longer facilitate arms deals between Europe and its own companies. From Jeff Bialos, partner and co-head of the aerospace, defence and security group at Eversheds Sutherland, a law firm, formerly a high-ranking official at the DoD:

European purchases of US weapon systems rose in part due to rising European defence spending [from the Ukraine war], including where the US provided replacement systems for those European allies. [In that type of transaction] country A sends their older system to Ukraine, paid for by the US, and the US defence companies sold them a more modernised system . . . If that winds down, that impacts US defence exports.

The European defence trade looks like it has some room to run.

One good read

Teaching while dying.

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