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Domestic-focused stocks outperform exporters

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Small-caps and smaller markets beat bigger counterparts

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EU/US deal for 15% tariffs removes layer of uncertainty

By Lucy Raitano and Linda Pasquini

LONDON/GDANSK, July 28 (Reuters) - European stocks are

near record highs again, seemingly shaking off tense trade talks

and currency headwinds, while volatility has evaporated, giving

rise to four key themes that investors are playing as they wait

for the next major catalyst.

The STOXX 600 posted its best first-quarter relative to the

S&P 500 in a decade - but is now clocking an 8.4% gain in 2025,

just a touch ahead of the S&P 500's 8.2% rise.

The European Union over the weekend reached a framework deal

with the U.S. for tariffs of 15%. But optimism has been building

for some time that the two sides would avert a damaging trade

war and the data points to an economy that is holding up for

now. Investors are warming to four key themes at play under the

surface of the European stock market.

1) EXPORTERS LAG DOMESTIC-FOCUSED STOCKS

A performance gap has emerged between euro zone

domestic-focused stocks and exporters, all thanks to a stronger

euro, which has risen 13.4% versus the dollar in 2025,

hurting exporter earnings.

Trade-sensitive sectors like autos and consumer durables

have fallen behind, while domestically-oriented stocks like

banks and utilities have soared.

A STOXX autos basket added over 3% last week after

news of a U.S.-Japan trade deal, but is still about 1% lower in

2025, a stark contrast to a 35% increase in bank stocks

and 15% surge in utilities.

Analysts have been revising down overall 2025 earnings

forecasts in Europe, but zooming in, there is a clear split

between the pace of earnings revisions for euro zone exporters

versus domestic plays, with the forward EPS of exporters

dropping at an accelerated pace.

JPMorgan equity strategists advise clients to keep favouring

domestics over exporters in their non-U.S. portfolios, while

Barclays equity strategists say the current positioning gap is

so extreme that the risk of a reversal is rising.

Helen Jewell, CIO of BlackRock Fundamental Equities

EMEA, flagged select opportunities in the export-focused luxury

and semiconductor sectors.

"If we get some resolution of where the tariffs are and if

we get some sort of levelling out of the dollar, I think these

names will start to perform well, and that could potentially be

the second leg for the European story," Jewell said.

2) HALO EFFECT

Germany's massive spending plans, aimed at boosting the

country's economy after decades of fiscal conservatism, brought

optimism to broader European markets, as EU companies are set to

benefit from increased spending on defense and infrastructure.

The U.S. tariff announcement in April caused a massive stock

sell-off, but the German DAX has since recovered to

touch a fresh year high in July. Midcap stocks have

followed a similar path. Both indexes are up over 20% this year

and set for their strongest annual performance since 2019.

"The relevance of Germany as a market for EU countries is

great," Uwe Hohmann, equity strategist at Metzler Capital

Markets said, pointing to the country's strong trade

relationship with other EU states.

Germany's spending plans will have a modest effect on

European growth, according to the European Commission's spring

economic forecasts, but the market impact is expected to be

profound.

"...the optimism around the German fiscal balance will still

be the main driver of European markets in the next years," said

Nabil Milali, portfolio manager at Edmond de Rothschild Asset

Management, warning however that money will not concretely flow

into the economy until 2026 at least.

A potential deterioration in trade relationships with the

U.S. or China could dampen sentiment on European equity markets,

at least in the short term.

"It would then only and mostly solely depend on what's going

on in the German political arena, which is, I think, probably

not good enough on a standalone basis to support an overall

positive trend," said Hohmann.

3) SMALL CAPS STEAL THE SPOTLIGHT

European small-caps are on track to outperform large-caps in

Europe for the first time since 2020.

A basket of European small caps is up 13.4%

in 2025, outperforming its large cap counterpart

which is up 9.1%, for the first time since 2020. Since April,

Graham Secker, head of equity strategy, Pictet Wealth Management

said a stronger euro and better economic outlook have driven the

small-cap turnaround.

"European small-caps were the proverbial value-trap: you're

cheap but you stay cheap until something changes," said Secker,

adding that in illiquid areas of the market, it doesn't take

much to move the dial.

"There has been a lot of interest with the fiscal stimulus

announcement out of Germany for revisiting German mid- and

small-caps, as probably the cleanest way to play the fiscal push

that's coming through Europe," Secker said.

4) SMALLER MARKETS ALSO PACK A PUNCH

Talking size, some smaller markets have also been

outperforming the wider European landscape this year.

Indexes in Czech Republic, Greece and Poland

have added 25%, 35% and 37%, respectively, compared with

an 8% rise in the STOXX 600.

"I think the positioning of investors is going more and more

towards these smaller markets" which are benefiting from

sectorial factors and higher exposure to the domestic economy,

said Edmond de Rothschild's Milali.