Podcast Summary: Thoughts on the Market – Episode: Faceoff: U.S. vs. European Equities

Introduction and Context

In the April 2, 2025 episode of Thoughts on the Market, Morgan Stanley’s Paul Walsh hosts a pivotal discussion featuring Mike Wilson, the Chief Investment Officer (CIO) and Chief US Equity Strategist, and Marina Zavolok, the Chief European Equity Strategist. The episode, titled "Faceoff: U.S. vs. European Equities," delves into the contrasting performances of U.S. and European stock markets, exploring whether Europe can maintain its recent outperformance or if a tactical reversal is imminent.

Year-to-Date Market Performance

Paul Walsh opens the discussion by highlighting Europe’s notable stock market outperformance compared to the U.S. This performance has been primarily driven by sectors such as defense and banking. In contrast, U.S. equities have experienced consistent weakness due to various well-documented factors. Walsh poses a critical question to Mike Wilson regarding the potential for a tactical rotation back into U.S. equities.

US Equity Market Analysis

Mike Wilson responds by expressing surprise at Europe’s substantial gains, attributing much of it to capital flows rather than a structural shift. He elaborates:

“I think the surprise for me anyways is just how much Europe has gone up. And I think a lot of that just has to do with flows and flows of capital.” [00:00]

Wilson underscores that the U.S. has been the top-performing market over the past decade, primarily fueled by large-cap growth stocks. He questions whether Europe’s outperformance is temporary or part of a more secular trend. He notes several headwinds that have impacted the U.S. market, including the Federal Reserve halting interest rate cuts in December, reversing fiscal impulses, and a slowdown in AI capital expenditures (CapEx).

European Equity Market Analysis

Transitioning to European equities, Marina Zavolok addresses the tactical situation following Europe’s strong performance. She emphasizes the critical role of earnings in sustaining market momentum:

“As we head into the 1Q earnings season a lot of investors are asking will Europe have this kind of outperformance in earnings that we saw last quarter?” [06:59]

Zavolok points out that European earnings revisions have outperformed the U.S., but notes that the current depreciation of the euro against the dollar is a headwind. She highlights Germany’s increased fiscal spending as a significant factor and compares it to the U.S. Infrastructure Investment and Jobs Act, suggesting that the next positive catalyst for Europe will be the release of detailed budget allocations expected in May or June.

Comparative Insights and Relative Performance

Paul Walsh probes further by asking Mike Wilson about the medium-term outlook for U.S. equities:

“How are you thinking about the outlook for the US Equity space as we kind of cast our gaze towards the end of this year and moving into 2026?” [04:44]

Wilson differentiates between the S&P 500 index and the average U.S. stock, praising the index for its quality and shareholder focus. He suggests that Europe could enhance its attractiveness by lowering taxes and regulations, potentially improving its relative opportunity set compared to the U.S. Wilson foresees a possible rotation of global investments back to the U.S. due to uncertainty and a shifting multipolar world.

Currency Exchange Impact

A significant portion of the discussion centers on the impact of currency exchange rates on earnings and market performance. Wilson explains:

“The dollar euro exchange rate which was very strong at the end of last year was a headwind for earnings growth for U.S. companies and a tailwind for European companies that now is reversed as the dollar has weakened substantially against the euro.” [01:34]

This reversal benefits European earnings relative to the U.S., potentially altering the earnings revision breadth between the two regions.

Tactical Opportunities and Strategic Outlook

Wilson identifies a tactical opportunity where the S&P 500 may offer an additional 3-5% of relative value over European stacks in U.S. dollar terms. He also warns of broader geopolitical shifts, such as the evolution towards a mercantilist environment and possible currency accords that could redistribute global assets away from the U.S.

Medium-term Structural Dynamics

Marina Zavolok discusses the structural dynamics underpinning European equities’ performance. She notes that the discount of European stocks versus the U.S. has remained within a stable downward range over the past decade. Zavolok believes that Europe may break out of this range in the second half of the year due to:

1. Repatriation of Investments: Investors moving away from concentrated U.S. indices back to Europe.
2. Diversification Themes: Potential shifts of global investments towards Asia and emerging markets.
3. Renewed Self-Reliance: Europe's focus on investing in its own future could drive a structural breakout.

“This kind of renewed self reliance of Europe investing in Europeans future, it can become a very bullish story.” [08:24]

Conclusion

The episode concludes with Paul Walsh thanking Mike Wilson and Marina Zavolok for their insightful analysis. He underscores the importance of understanding the relative merits of U.S. and European equity strategies, especially in a rapidly evolving global market landscape. Listeners are encouraged to share the podcast and leave reviews to support future discussions.

Notable Quotes

• Paul Walsh [00:00]: "Investors are asking if Europe can sustain its recent stock market outperformance against the U.S. or if we're poised for a tactical reversal."

• Mike Wilson [01:34]: "The key from my side is I sense you think there may be a tactical opportunity here and that we could be on the cusp of seeing something of a rotation back into US Equities."

• Marina Zavolok [06:59]: "The next positive catalyst we expect in Germany are going to be with the release of the budget when we get more details on how the money will be spent."

• Marina Zavolok [08:24]: "This kind of renewed self reliance of Europe investing in Europeans future, it can become a very bullish story."

Key Takeaways

1. Europe’s Outperformance: Driven by defense and banking sectors, supported by favorable earnings revisions and advantageous currency movements.
2. U.S. Market Challenges: Faced with policy rate stabilization, reversing fiscal impulses, and slowing AI-related investments impacting growth stocks.
3. Currency Impact: The weakening dollar against the euro is a critical factor benefiting European earnings in the current phase.
4. Tactical Rotation Potential: There is an anticipated 3-5% relative value opportunity in the U.S. S&P 500 over European equities.
5. Structural Shifts: Europe's potential to break out of its historical discount to the U.S. through increased diversification and self-reliance investments.

This comprehensive discussion provides investors with a nuanced understanding of the current dynamics between U.S. and European equities, highlighting both tactical opportunities and long-term structural considerations.