By Joachim Klement
The year started off well for European stock markets, with attention-grabbing outperformance versus the U.S. But what was really needed to reverse the multi-year trend of European equity outflows was a fundamental catalyst. With DeepSeek, investors may have found it.
European investors have shunned their domestic equity market in favour of the U.S. for years, but this started to change in recent months. Initially, this appeared to be triggered by worries about the high valuations of the U.S. stock market and declining earnings growth in high-flying tech names.
The uncertainty surrounding the implications of the U.S. presidential elections in November – concerns justified by President Donald Trump’s tariff announcement on Saturday – may also have caused some investors to take profits and trim their U.S. holdings.
But then came the news that Chinese AI company DeepSeek had developed an inexpensive rival to the dominant U.S.-created large language models. This has further called into question growth expectations for some AI-related U.S. juggernauts as well as the significant premium European investors have been paying by favouring U.S. equities.
European stocks have arguably become very cheap relative to the U.S. in recent years. Adjusted for differences in sector composition, the European stock market currently trades at a 33% discount, larger than at any point in the last 35 years.
But every value investor knows that cheap stocks can stay cheap for a long time if investors don’t recognise the value. This recognition, though, may now be emerging.
European investors have become increasingly wary of expensive U.S. stocks, according to the most recent release of the U.S. Treasury International Capital (TIC) system data, the most comprehensive source of cross-border investment flows available.
In November 2024, European investors’ net sales of U.S. stocks neared $54 billion, an acceleration of the net sales that occurred throughout much of 2024. Three of the five largest monthly outflows of the last three years occurred in the second half of 2024.
Unfortunately, European countries don’t publish similar data sets, so it is impossible to definitively say whether Europeans are putting this money to work at home.
But we can look at European equity fund flows for guidance.
Examining a broad set of 479 actively managed funds and 100 index funds that invest in euro zone equities shows that three years of net outflows came to an end in late 2024. In fact, both December and January saw small net inflows into euro zone equity funds.
True, this is only a snapshot of total European investment flows. And it is too early to tell if this really marks a persistent change in investor preferences, as there have been false signals before.
But what is different this time is that there may be a clear catalyst. With the advent of DeepSeek, we may have a fundamental trigger that could accelerate the emergent reversal of investment flows.
I am not in the camp that claims U.S. tech stocks are heading for a major crash. However, if investors in the coming months have to reassess how much investment is needed to roll out generative AI technology and how fast earnings of AI-related companies can grow, then European stocks could be the haven investors seek to weather the storm created by this potentially radical reassessment of valuations.
Why Europe? The Stoxx Europe 600 only has a handful of companies directly exposed to the AI theme, collectively accounting for roughly 2.0% of the index. In Asia, the exposure is higher at 7%, thanks to the dominance of TSMC, the Taiwanese semiconductor giant. But that is dwarfed by the S&P 500’s AI exposure, which represents almost one-third of the market cap.
Of course, the apparent arrival of low-cost AI should boost some tech companies in the US, as it will likely increase AI adoption by businesses that may have previously balked at the high price tag. Companies like Meta or Oracle, in particular, could benefit.
But big infrastructure providers, such as Nvidia, Broadcom and Microsoft, that have seen their share prices surge based on the anticipated need for massive spending on advanced chips or expensive LLMs will likely suffer.
It is also true that Europe’s chances of facing U.S. tariffs increased on Saturday when Trump followed through on his threats to slap broad tariffs on Canada, Mexico and China. But Europe is less exposed to U.S. trade than these three countries, so it could turn out to be a relative winner if a global trade war ensues.
Ultimately, if AI stocks and technology stocks more generally lose their appeal, European equities are the natural place to gravitate – at least for now. In short, what was a disadvantage for many years could become a major plus in 2025.
(Joachim Klement is an investment strategist at Panmure Liberum, the UK’s largest independent investment bank).
(Writing by Joachim Klement; Editing by Anna Szymanski.)
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