A feature of the rally that has delivered solid performance for European equity in 2025 has been the narrowness of the gains, with banks, utilities and defence businesses dominating.
Apart from the fact those sectors are predominantly large cap, the other commonality is the exposure predominantly to the domestic European economy, as the potential impact of tariffs impedes the progress of businesses that are export-led.
But the question is whether the impact of looser fiscal policy, which has positively impacted the defence sector in particular, can have a broader impact on the European economy and provide gains to other parts of the market, including mid and small companies, which tend to be sensitive to the domestic economy rather than to global events.
Repeated interest rate cuts by the European Central Bank may also be positive for the asset class, as liquidity and risk premia change.
JPMorgan Asset Management’s head of international equities, Malcolm Smith, says a key driver of performance for European domestically focused equities from here could be driven both by the fiscal policy announcements and by regulatory reforms designed to make the economy more competitive.
Those reforms were contained in a report produced by former ECB president Mario Draghi, “The future of European competitiveness”, and published in September 2024.
Commenting in a global context, Nish Patel, who runs the Global Smaller Companies investment trust for Columbia Threadneedle, says rate cuts are generally positive for smaller companies, as they increase risk appetite. He notes a world in which inflation remains persistently above target could also help smaller companies relative to larger businesses as, in his view, smaller companies are less bureaucratic and so have greater capacity to pass price increases on, or deal with the need to cut costs to maintain margins.
His global fund has been actively buying in Europe; he commented that the recent announcements around increased defence and infrastructure spending in the economic bloc has increased the “visibility” of earnings of companies in those sectors, adding an element of security.
Hilde Jenssen, an equity fund manager at Nordea, says one of the principal risks associated with investing in European equities right now is political risk because, while agreements have been reached, the extent and timeframe for the execution of those remains up in the air.
But she is quite positive on small and mid-caps more generally, as she says the greater domestic focus has the potential to benefit from the higher spending.
Laura Cooper, global investment strategist at Nuveen, is another who expects small caps to benefit from the stimulus. She describes the stimulus programmes as “a game-changer” for the outlook for the European economy (and for mid and small-cap stocks), which she says has not performed of late, despite the wider positive performance of the market.