Navigating growth and risks in the European market

European equities have garnered more interest as investors reduce their exposure to the US amid escalating trade tensions under President Donald Trump. While Europe has had its fair share of challenges in the past, such as the EU debt crisis in 2009, a technical recession in 2022-2023 and the Russia/Ukraine conflict, it’s hard to ignore its increasing appeal for investors.

There are several factors that have created a more optimistic outlook on Europe, including favourable fiscal conditions and attractive market valuations. But while there is the potential for European equities to do well, there are also associated risks to consider for investors.

One of the factors contributing to the positive outlook in Europe is the increased and strategic investments in the defence sector. The European Investment Fund (EIF) recently announced a dedicated fund for the defence sector, targeting early-stage companies¹. This initiative aligns with the InvestEU programme, which aims to boost investment in the sector by nearly €400 million. Meanwhile the European Investment Bank has also raised the finance ceiling to a record €100 billion to boost funding for security, defence, energy grids and the new TechEU programme². The timing is significant, with a NATO meeting last month to outline future defence spending. Current geopolitical tensions are accelerating the urgency of these investments.

Germany is leading the way with its commitment to increased defence spending and is set to boost it to 3.5% of gross domestic product (GDP) by 2029. The country is funding this through a defence fund and through reforming its so-called debt brake, which previously limited the nation’s ability to incur new debt. Germany can, however, afford to increase its capacity to borrow as its public debt is relatively low at 62.5%³.

This surge in investment is likely to create jobs and drive wage growth within the sector. As a result, more money will flow into European consumers' pockets, potentially boosting discretionary spending in other sectors. This ripple effect can stimulate broader economic growth and enhance the performance of European equities.

The fiscal boost from increased defence spending, coupled with lower interest rates (compared to other economies), provides a reasonably strong backdrop for European equities. Lower interest rates have been beneficial as they’ve reduced borrowing costs for companies, encouraging investment and expansion. This environment supports corporate profitability and can lead to higher stock prices.

Interest rates in Europe are currently on a downward trend, with the European Central Bank (ECB) cutting its key policy rate by 0.25 percentage points in June/this month (depends on when this gets published). This move is part of a broader effort by the European Central Bank (ECB), to support economies amid ongoing trade uncertainties. The expectation of further rate cuts continues to create a favourable environment for corporate growth and investment.

European markets have traditionally traded at less demanding levels compared to other developed markets, such as the S&P 500. This suggests there is scope for improving valuations if positive changes materialise. Investors seeking value may find European equities particularly appealing, as they offer the potential for significant upside. 

European equities offer a different type of exposure compared to US markets. They tend to have higher dividend yields, making them attractive to investors seeking an income from their portfolio or those taking a total return approach.

Additionally, European markets are less tech-heavy and more industrial-focused. This composition allows them to cope better with inflationary pressures, as industrial companies can pass on higher costs to consumers without significant price increases.

Currency diversification is another advantage. Investing in European equities provides exposure to the euro, which can help protect against dollar devaluation. This diversification can enhance portfolio stability and reduce currency risk. However, on the flip side, it’s important to remember that investments denominated in a currency other than sterling may expose you to the risk of fluctuating exchange rates.

Despite the positive factors, there are risks too. The Eurostoxx index has already gained almost 9.1% in local currency this year (13.7% in sterling)⁴. This raises the question of whether all the positive news is already priced in. If so, the potential for further gains may be limited. There is also always the risk of further volatility and the possibility that you could get back less than what you invested.

Different funds carry varying levels of risk depending on the geographical region and industry sector in which they invest. You should make yourself aware of these specific risks prior to investing.

Continued trade tariff concerns and the cost of adapting to new regulations could also impact company earnings. Trade tensions and regulatory changes can increase operational costs and reduce profitability, posing a risk to the performance of European equities.

European equities present a compelling investment opportunity, driven by strategic investments, favourable fiscal conditions, attractive valuations and diverse market exposure. However, investors must remain mindful of the potential risks, including market overvaluation and trade-related challenges. A well-rounded investment strategy that considers both the opportunities and risks can help navigate the dynamic landscape of European equities.

Evelyn Partners offers combined wealth management services with professional advisers and investment managers who can help you work towards your financial objectives and establish whether investing in European equities is right for your portfolio. To explore ways to balance your portfolio, please book an appointment or speak to your usual Evelyn Partners contact.

1. EIF.org, EIF announces €40 million investing in Keen Venture Partners’ European defence and security Tech fund under Invest EU, 22 May 2025
2. BR Business Review, EIB Group raises 2025 financing ceiling to record €100 billion to step up investments in security, energy, European tech leadership, 23 June 2025
3. Trading Economics, Germany Government Debt to GDP
4. Evelyn Partners/LSEG Datastream, correct as of 4 July 2025