European stocks have been outperforming U.S. stocks this year by a fairly wide margin. The STOXX 600, which is roughly the equivalent of the S&P 500, is up about 8.3% year-to-date. Further, the MSCI Europe Index, which contains large and mid-cap stocks, is up 9.5% YTD.
In comparison, the S&P 500 index is down roughly 3.7% YTD while the Russell 1000 has dropped 3.8% YTD.
Goldman Sachs Research recently released a report examining why the European market has outperformed, and what to expect in the future. According to Goldman Sachs Research Senior Strategist Sharon Bell, there are several factors at play, including low expectations.
“Investors were very skeptical about Europe going into this year — on the economy, on the impact of Trump policies and tariffs, and on growth. Because markets had already priced in a fairly weak growth profile this year, Europe only had to perform in line with expectations (or slightly better) and it could do very well,” Bell said in the Goldman Sachs report.
At the same time, European stocks have benefitted from strong corporate earnings, along with lower valuations. While U.S. stocks have been way overvalued, and still are, European stocks have largely been good values. While valuations have risen in Europe during this rally, they remain well below U.S. stock valuations.
“The US has gone down a fraction, and Europe’s gone up a fraction. So that elastic band that got stretched very far between US valuations and European valuations has come back in a tiny bit,” Bell said. “It’s still very stretched, though — not because Europe is very cheap, but because the US is still near historically high valuations.
Defense spending spikes
Another big reason is an increase in defense spending, particularly in Germany, to support Ukraine amid uncertainty from the U.S.
“Stocks have also risen because of the growing understanding that Europe will have to spend more on defense: If there’s no peace in Ukraine, Europe spends more on defense; if there is peace in Ukraine, Europe has to ensure that peace and therefore spend more on defense,” Bell said. “Either way, Europe spends more on defense, which helps defense companies.”
Due to the rise in defense and infrastructure spending, Goldman Sachs Research boosted its forecast for real GDP growth in Germany this year to 0.2% from flat. They also increased the 2026 GDP forecast to 1.5%, from 1.0%, and the 2027 GDP estimate to 2%, from 1.4%.
Goldman Sachs also hiked its GDP forecasts for the larger Euro zone to 0.8% in 2025, 1.3% in 2026, and 1.6% in 2027.
“One reason is that we expect stronger growth in Germany to spill over into neighboring countries,” Goldman Sachs Research Chief European Economist Sven Jari Stehn stated. “Another reason is that we now expect the rest of the euro area to step up military spending somewhat more quickly in response to the German announcement.”
Researchers expect Spain, France, and Italy to be among those nations that boost defense spending.
Can the outperformance continue?
Looking ahead, Goldman Sachs Researchers say European stocks are well-positioned for continued growth. One wildcard is tariffs. Europe has not been hit hard by new U.S. tariffs yet, and if that changes, it could have an impact. But the U.S. is also dealing with tariffs, which have already had a negative effect on U.S. stocks.
“I do still see upside for the remainder of this year: Our 12-month target still has 5-6% upside,” Bell said. “But the market’s already up 10-12% since the start of the year, so I feel we’ve already had a lot of the returns on European equities.”
With European economies expected to grow over the next few years, buoyed by defense, infrastructure, and government spending, corporations should benefit, giving European stocks a tailwind.
Goldman Sachs Research is neutral on both the U.S. and Europe, in terms of which will outperform. But Bell suggested that Europe could “do a bit better if it can make a few key changes that it hasn’t managed to implement in recent years: improving its infrastructure, spending a bit more on defense, bringing down energy prices for consumers and industry, and Germany spending more fiscally to support its economy.”
But the key, she said, is having a portfolio with a balance of both U.S. and European stocks. “Diversification is the answer,” Bell said.