“When is there not a problem in Europe?” is a line that was often batted back to me in the fifteen or so years following the credit crunch, as the economy significantly underperformed the US due to structural, policy, sector and capital-market issues.
Between March 2009 and the end of 2024, the MSCI Europe produced less than a third of the returns of the S&P 500 (310% versus 1,062%). It was at this time that many European fund managers were quick to highlight Europe as home to several great companies with a global footprint. It is a leader in the drive to innovate in the renewable energy and green technology space, has a few successful companies in areas like healthcare and luxury goods and is well exposed to several cyclical names.
Roughly two thirds of the revenues of Europe’s companies are international in nature – names like SAP, Roche, L’Oréal and ASML have continued to produce strong sales outside of Europe. However, Europe has been hampered by the stuttering performance of many domestic names.
But things have started to change in the past 18 months, as domestic-oriented European shares outperformed export-heavy European stocks driven by trade uncertainty and expectations of US dollar weakness.
I want to dive into a couple of the catalysts in a bit more detail. Firstly, Germany announced a €1trn fiscal programme focused on defence and infrastructure investment. This bolstered European growth expectations and directly benefited domestically-oriented small-cap sectors.
European PMI has also been rebounding and is now in expansionary territory. Manufacturing hit a PMI of 50.8 in February 2026 (50 means we are in an expansionary phase). Services PMI in the Eurozone also increased to 51.8 in February 2026.
JPMorgan European Growth & Income co-manager Tim Lewis says that lows like the Russian invasion of Ukraine created a challenging environment for domestic Europe in recent years, but he believes the German debt break at the start of last year was a big boost for many domestically focused names.
He says: “Attractive valuations, coupled with stimulus, have bolstered what is already a good economic story in Europe. There is also scope for more upside given the excess savings rates among European consumers. Most of the globally-focused consumer businesses we talk to often highlight the European consumer as the market with the most upside.”
For a bit of clarity, in the euro area, households have been saving about 15% of their disposable income (this is up from 12-13% pre-Covid). By contrast, US personal savings sit in the 3-5% region.
Fidelity European Trust co-manager Marcel Stotzel describes Europe as an airplane with three engines; the first two (international revenues) have done well for the past 15 years, but the domestic engine has only been switched on since the start of 2025 and that has increased the potential growth and opportunities within the European economy.
He says increased defence spending and the German fiscal break were two things he never thought would happen in Europe – and that they increase the chances of other changes, such as less regulation, better integration of the euro-market and the scope for tapping into those consumer savings. He believes these changes could close the GDP growth gap with the US and result in elevated multiples across the European economy.
Small-caps play a big role but other sectors are also benefitting
Small-caps obviously play a major part in this recovery. At a time of heightened geopolitical tensions and new trade tariffs, the fact that small and micro-cap companies tend to be more focused on domestic markets means they also tend to be less exposed to these headwinds. Lower rates and moderating inflation also play into their hands, as does the improved economic outlook for the region, with the IMF predicting GDP growth of 1.2% in 2025 and 1.1% in 2026.
But there is much more to the story than just investing further down the market cap scale. Domestically-focused stocks in the likes of the defence and banking sectors have also started to benefit. Stotzel says banks, for example, have significantly further to run because if the economy improves, people will look to take out more loans. “You also have to consider that all these new types of fiscal spending will often be financed with some borrowing with the likes of government and corporate debt,” he says.
Still further to run
Lewis says this change in fortunes for domestic companies could be a long-term play, adding that Europe has never been quick to bend and move red tape out of the way for progress. By contrast he says that for other markets, stimulus is more like a sugar rush that goes straight into the consumers’ pockets, allowing them to spend quicker.
He cites electric utility company E.ON as a good example of the long-term approach.
He says: “Over 40% of Europe’s grid infrastructure is over 40 years old – meeting the challenge of greater power demand from AI and renewable energy is already a big infrastructure uplift, which E.ON is a big part of.
“So, when Germany is talking about fiscal spend, some of this is going towards modernising the power grid and these other areas. It benefits E.ON because they need to get a regulated return from the German government and Germany has to offer a supportive regulatory framework, so they do not undermine their broader goals by failing to build the grid infrastructure. No one is upgrading yet – but the visibility of growth for a company like E.ON is becoming a lot clearer.”
Europe had a good 2025, but there is significant scope for further growth given its years in the wilderness following the Global Financial Crisis. European small-caps will play a big role – I recently read that they were trading at a 10% discount to the MSCI Europe in 2025 (having traditionally traded at a premium of 10%). Names like IFSL Marlborough European Special Situations and Montanaro European Income are good examples of stockpickers worth considering. But there are also opportunities further up the market cap spectrum, with names like Fidelity European Trust, JPMorgan European Growth & Income and Liontrust European Dynamic also tapping into this trend.
Darius McDermott is managing director of FundCalibre and Chelsea Financial Services. The views expressed above are his own and do not constitute financial advice. Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time.