The total unpredictability and the unprecedented policy shifts of the Trump administration, along with Europe’s seismic response to these, have led to a drastic reversal in investor sentiment and positioning in recent times. Experts at Xtrackers by DWS have identified several significant changes in performance and asset allocation, including that investors are moving away from U.S. equities and the Magnificent Seven toward regions previously “forgotten” and with low exposure such as, for example, Europe and China.
“There is a clear reversal in the European narrative following the elections in Germany and the change in the U.S. approach to the conflict between Russia and Ukraine. From our point of view, this makes the recent rally in Europe more than just a reversal effect. In times of high uncertainty, ETF flows seem to indicate that the market has finally heard the wake-up call for greater diversification beyond U.S. large caps,” they explain.
Chart: Relative performance versus the S&P 500 (last 12 months, total return in dollars)
U.S. equity ETFs are seeing a sharp drop in new inflows, as investors turn to European, global, and emerging market indices.
One of the main conclusions they draw is that the market inflection point could open opportunities to recalibrate portfolios, as these are experiencing a key reversal of the so-called “Trump Trade”, with a sharp drop in U.S. equities so far this year. In contrast, they point out that more attractive valuations of European equities, along with announcements of larger infrastructure and defense investments, have pushed markets upward in Europe. “This movement is supported by structural factors, such as the new uncertainties around AI and the capital expenditure (capex) investment story that comes with it, as well as the renewed fiscal momentum in Europe,” they clarify in their latest analysis.
At the same time, they believe that geopolitical tensions could make recalibrating risk exposure a priority: “For investors, this represents a window to reposition their portfolios, diversify beyond traditional winners and take advantage of evolving macroeconomic and thematic drivers. Several regions and sectors have been identified as structural laggards by investors (including Europe, China, and the world excluding the U.S.). With very low initial sentiment and a new geopolitical environment, these could become candidates for sustained recovery.”
The New Narrative: Europe’s “Whatever It Takes”
On one hand, the experts point out that a possible ceasefire between Russia and Ukraine is improving market sentiment, which contrasts with the urgency of EU members to substantially increase defense spending, with the goal of reducing their dependence on the U.S. “Germany has announced plans to make major investments in infrastructure and defense, financed through a relaxation of the debt brake and a special fund of 500 billion euros. This could increase indebtedness and the public debt ratio, but at the same time boost economic growth. Other EU countries are likely to follow this path,” they note as an example.
From the firm, they expect these measures to accelerate growth, especially starting next year. Xtrackers forecasts estimate that Germany will grow 0.4% in 2025 and 1.6% in 2026. For the Eurozone as a whole, they project growth of 1% in 2025 and 1.5% in 2026. Meanwhile, the ECB has further supported European markets with interest rate cuts, making equities more attractive compared to traditional savings products and, over time, easing the interest burden for companies.
Lastly, private consumption is beginning to recover thanks to a surprisingly strong labor market and declining inflation. Additionally, macroeconomic surprise indicators have turned positive for Europe. “We believe the euro could strengthen in the short and medium term. Moreover, European stocks, especially mid-caps, which have lagged in the recent rally, could benefit from the planned spending increase,” the analysts explained, adding that Europe’s macroeconomic momentum has become a tailwind for equities so far this year, while U.S. indicators have turned downward.
“Positive economic environment, positive risk appetite, positive structural factors (the historically forecasted higher EPS should drive superior profitability over the cycle, the adjusted valuation of Europe’s SME sector compared to large caps is below the historical average), greater domestic market exposure than large-cap companies,” conclude the experts at Xtrackers.
