European small-caps outshine US rivals as investors bet on growth revival

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Europe’s smaller stocks have raced ahead of their US peers this year as investors bet on an economic resurgence while trying to steer clear of companies most exposed to Donald Trump’s trade war.

Investors have flocked to previously unloved small- and medium-sized companies in Europe, drawn by lower interest rates and the promise of a growth boost from Germany’s historic €1tn stimulus plan.

Across the Atlantic, Wall Street’s rebound from the sharp decline after President Trump announced sweeping tariffs in early April has been fuelled by the country’s “megacap” tech stocks. Smaller equities, which tend to be more tied to the fortunes of the domestic economy, have been left behind.

This has meant that this year’s divergence between European and US equities has been especially pronounced among small- and mid-cap stocks.

Since the beginning of 2025, the MSCI Europe small- and mid-cap index has risen 10.7 per cent, while the same index for the US has fallen 2.6 per cent. 

Equivalent indices for larger companies are up 7 per cent in Europe and 1.2 per cent in the US.

“We’ve seen an increased interest, particularly from US investors, in European mid-cap names,” said Aleksander Peterc, head of small- and mid-cap equity research at Bernstein. Clients are “looking for high quality, overlooked stocks, preferably exposed to European infrastructure spending and the German ‘bazooka’”, he added.

Falling borrowing costs have also helped. The European Central Bank has halved interest rates from a peak of 4 per cent in June following the latest cut on Thursday. That contrasts with the US, where Federal Reserve policymakers have moved more slowly and indicated they want to wait and see the impact of Trump’s tariffs on inflation before reducing rates further.

“We used to have US mid-caps [in our portfolio], but . . . US mid-caps work when you have the Fed easing and growth upgrades. We’re seeing none of these in the US,” said George Efstathopoulos, multi asset portfolio manager at Fidelity International.

In Europe, smaller equities have underperformed larger ones by 19 per cent since the start of 2022, but that gap has started to narrow this year.

But a relative return of optimism around growth, along with concerns that the trade war will hurt larger export-focused stocks, have helped to narrow that gap in 2025.

“Post-liberation day we bought the weakness in German mid-caps and Greek equities, which has been a “very strong performing story”, Efstathopoulos said.

“We are playing the domestic revenue generation theme in a world of trade disruption,” he added.

Some analysts also say that smaller European firms have benefited from a renewed enthusiasm for stockpicking strategies, as investors try to pick winners and losers from Trump’s trade onslaught.

“I am speaking to people who would typically only invest passively around the world, and when they’re looking at Europe, they’re specifically looking at active allocations,” said Gerry Fowler, head of European equity strategy at UBS. “They want someone who understands that the prospects of companies in Europe differ quite wildly in the current context of tariffs, currency movements, stimulus plans.”

Fowler added that it was “very hard to make a case for US small-caps”, largely due to fears about the effect of Trump’s policymaking on the US economy.