(Bloomberg) — The engines behind the past two years of gains in European stock markets are losing steam, sending the region’s equity markets into a tailspin as concerns about slowing growth and tensions in China test investor confidence.
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A luxury sector led by LVMH Moët Hennessy Louis Vuitton SE has fallen over the past six months, as have auto companies, while healthcare heavyweights such as Novo Nordisk A/S and tech leaders including ASML Holding NV have slipped from their peaks in more recent months. And with no clear candidates to take over, the region’s stock performance has been fragile.
Already this year, investors have pulled billions of dollars out of Europe-focused funds and ETFs, in stark contrast to the large sums pumped into US and international equity funds. Crucially, the main drivers of the region’s profits are lagging behind the US’s Magnificent Seven group of technology companies.
“Leadership is changing” in the European market, said Ariane Hayate, a fund manager at Edmond de Rothschild Asset Management. “Smaller and more defensive sectors are leading the way.”
The European market is inherently more cyclical than its US counterpart, with those economically sensitive sectors accounting for around two-thirds of the benchmark Stoxx 600. As a result, the index’s correlation to the group tends to be very high. But any support for these companies is now at risk with the double whammy of slowing growth and trade risks with China.
“These companies also have a large percentage of their revenues coming from the US and China,” said Barclays Plc strategist Ajay Rajadhyaksha. “If the risks of a global trade war increase, it’s very easy to see these names getting downgraded somewhat on trade concerns.”
Growth problem
Meanwhile, Europe is increasingly focused on Chinese demand. According to strategists at Goldman Sachs Group Inc., companies make about 8% of their revenue in the Asian country, compared with just 2% for peers in the S&P 500.
While some argue that the risk of trade wars could increase if Donald Trump comes to power, Europe is already planning additional tariffs on electric vehicles produced in China due to fierce competition.
Another spillover effect from China’s economic woes is oil prices not seen since 2021, clouding the outlook for European energy giants such as BP Plc, Shell Plc and TotalEnergies SE. London mining stocks are also suffering from falling iron ore and copper prices.
In the US, on the other hand, Big Tech has been a major driver, with six stocks in the benchmark’s top 10, accounting for more than 50% of returns.
In Europe, four of the top 10 contributors to the Stoxx 600 index’s returns this year come from the healthcare sector. Adding consumer goods company Unilever Plc takes the contribution of these five companies to performance to over 30%. This defensive bias is unlikely to deliver the same power as cyclical companies such as luxury goods.
While 2025 earnings estimates have generally held up so far, Barclays’ Rajadhyaksha expects data surprises to be more damaging than helpful.
Earnings estimates could indeed be at risk for the region. A Citigroup Inc. gauge of earnings revisions that factors in earnings upgrades and downgrades has been negative for most of the summer.
Sector rotation
As the European market’s former darlings fade, investors are rotating vigorously in search of new opportunities. For Gilles Guibout, a Paris-based portfolio manager at Axa Investment Managers, some segments of the stock market look promising if the economy settles for a soft landing.
“Rising dividends can help boost valuations and who pays dividends? Banks and utilities,” he said.
European banks have had a stellar year so far, up 18%, and he argues there is room for further gains given low valuations. Investor interest in the sector has also increased since UniCredit SpA CEO Andrea Orcel said he was considering a full takeover of Germany’s Commerzbank AG.
“For utilities, lower interest rates provide immediate relief and they have already started outperforming this summer. There are prospects for rising dividends, rising earnings and multiple expansion in this sector,” Guibout added.
Other fund managers believe there are segments of the stock market that are poised to take over market leadership if a recession is averted.
“If we are indeed entering a soft landing, then it makes sense to bet on the broadening of the rally, to bet on the laggards, such as small and mid-caps,” said Amelie Derambure, a senior multi-asset portfolio manager at Amundi in Paris. “That’s why we are keeping a close eye on growth momentum indicators. Laggards could be the next driver of the market when economic growth picks up again.”
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