Key Takeaways
- A solid Q3 earnings season from AI stocks and expectations of interest rate cuts are helping US stock market sentiment.
- Ukraine peace talks have sent European defense stocks into reverse after a strong rally in 2025.
- European inflation and interest rates are low and GDP growth is expected to improve across the region.
With less than one month to go before the year ends, US and European stock markets are still neck and neck, but the momentum appears to have shifted toward the US. European markets hit their peak in mid-November, while US markets are right now trading at all time-highs.
What’s Driving the US Stock Market Resurgence?
With a solid earnings season in the bag from key AI stocks and the expectation of interest rate cuts front of mind, it’s understandable why US market investors are bullish as we close out the year.
Earnings season helped allay fears that growth might start slowing in the Magnificent Seven stocks, which now account for almost 40% of the Morningstar US Market Index. Nvidia NVDA, worth almost 8% of the entire stock market, posted revenue figures that were up more than 60% on last year, and earnings ahead of even lofty expectations.
And US investors were confident of an interest rate cut ahead of the Dec. 10 Federal Reserve announcement, a boost to markets.
European Stock Markets Lose Momentum
European stocks had been riding high in 2025, but stumbled in November as the start of Ukraine peace talks sent defense stocks in Europe sharply downward. This prevented the overall market from recovering in line with the US.
Defense stocks have become key to the European stock market’s fortunes: After rallying strongly over the past year or so, the sector now makes up almost 5% of the Morningstar Europe Index.
European defense stocks offer unmatched exposure to increased defense spending by NATO nations, mainly because many of these nations are based in Europe. That sort of exposure is unique to the European market, and simply cannot be gained through the purchase of either US or European large-cap equities, unlike AI, for example.
European defense stocks have pulled back from their peaks, however. Shares in Rheinmetall RHM, a bellwether in the defense sector, are now almost a quarter lower than they were in September.
Some global investors who had previously embraced the benefits of owning European equities for defense exposure are now likely to be less optimistic going into 2026.
Economic Fundamentals Are Still Strong in Europe
If European stocks markets ultimately underperform the US in 2025 it will be disappointing, but it’s important to remember that both stock markets are up more than 17% year to date in local currencies. That beats the 10% average annual return on global equities, and the year is not over yet.
Despite such strong performances this year, equity market valuations are still appealing: Both US and European stock markets are trading at a modest discount to their respective fair value estimates.
Meanwhile, the macroeconomic picture, although not perfect, is improving. The OECD has recently upgraded global GDP forecasts on the back of milder tariffs than had initially been baked in to forecasts.
Interest rates in Europe sit at just 2%, which should be a significant boon to equity markets in 2026. Inflation is under control, at around the ECB’s targeted level, which should allow for further interest rate cuts in the new year. GDP growth expectations in the region are certainly not amazing, but they are improving.
All of these factors should provide a solid backdrop for European equities next year. While 15%-plus returns might set the bar high for 2026, the potential for solid returns from European stocks is realistic.
