Europe’s stock market leaders fade in bad omens for future returns

(Bloomberg) — The engines behind two years of European stock gains are faltering, leaving shares in the region facing a gap at a time when concerns about slowing growth and tensions in China are testing investor confidence .

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A luxury sector led by LVMH Moët Hennessy Louis Vuitton SE has tumbled in the past six months, along with auto firms, while in more recent months healthcare heavyweights such as Novo Nordisk A/S and technology leaders including ASML Holding NW, have declined from the summit. And with no obvious candidates to pick up the baton, the performance of stocks in the region has been left in the dark.

Already this year, investors have pulled billions of dollars out of Europe-focused funds and ETFs, in stark contrast to the large sums being pumped into US and international equity funds. A key issue is that the region’s leading earnings drivers have fallen off the pace of America’s Magnificent Seven group of tech companies.

“Leadership is changing” in the European market, said Ariane Hayate, fund manager at Edmond de Rothschild Asset Management. “Smaller, more defensive sectors are leading the pack.”

The European market is by definition a more cyclical one than its US counterpart, with those economically sensitive sectors accounting for about two-thirds of the benchmark Stoxx 600. Consequently, the correlation of the index with the group is usually very high. But any support from these firms is now at risk, with a double whammy from slowing growth and trade risks with China.

“These companies also have a large percentage of their top line coming from the US and China,” said Barclays Plc strategist Ajay Rajadhyaksha. “If the risks of a global trade war are increasing, it’s very easy to see these names being reduced somewhat for commercial reasons.”

Growth problem

Europe, meanwhile, is geared more toward Chinese demand, with firms making about 8 percent of their revenue in the Asian country, according to Goldman Sachs Group Inc. strategists, compared with just 2 percent for S&P 500 peers.

While some say the risk of trade wars could be magnified under a Donald Trump administration, Europe is already planning additional tariffs on Chinese-made electric vehicles in the face of tough competition.

Another knock-on effect of China’s economic woes is oil prices at record lows since 2021, dimming the outlook for European energy heavyweights such as BP Plc, Shell Plc and TotalEnergies SE. London’s mining stocks are also suffering due to falling iron ore and copper prices.

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By contrast, in the US, Big Tech was a major driver, placing six stocks in the benchmark’s top 10 and delivering more than 50% of returns.

In Europe, four of the top 10 contributors to Stoxx 600 index returns this year have come from the healthcare sector. When staple food firm Unilever Plc is added, the contribution of these five companies to its performance rises to more than 30%. This defensive bias is unlikely to provide the same juice as cyclicals like luxury firms.

While earnings estimates have remained broadly flat so far for 2025, Barclays’ Rajadhyaksha believes data surprises are more likely to hurt than help.

Profit estimates may indeed be at risk for the region. A Citigroup Inc. indicator. of earnings revisions that take into account profit upgrades and downgrades was negative for most of the summer.

Sector rotation

With the disappearance of the former darlings of the European market, investors are spinning hard 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.

“Could Raising Dividends Help Boost Valuations And Who Pays Dividends? Banks and utilities,” he said.

European banks have had an excellent year so far, up 18%, and he argues there is room for further gains given the low valuations. Investor interest in the sector has also increased since UniCredit SpA chief executive 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 to outperform this summer. There are prospects for dividend growth, growing earnings and multiple expansion in this space,” added Guibout.

Going forward, other fund managers believe there are segments of the stock market poised to take over if a recession is avoided.

“If we’re really going into a soft landing, then it makes sense to bet on the extension of the rally, to bet on the laggards like small and midcaps,” said Amelie Derambure, senior multi-asset portfolio manager . at Amundi in Paris. “That’s why we’re watching growth momentum indicators very closely. Laggards could be the next market driver if economic growth returns.”

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