Three trusts for investing in cheap European stocks

Now that geopolitical tensions and rising trade tariffs have rocked the world economy, is it time to purchase European stocks?

Between the beginning of 2025 and the end of May, the SandP 500 gained just 0.5 percent, marking its slowest opening five months of a year since 2022.

In recent weeks, the US has become less dominant in the top stocks and funds for investors, forcing them to look to underappreciated areas like Europe.

The reason is clear from a glance at the year's top stories. The tariff chaos that Donald Trump imposed has raised concerns about a potential US recession and threatened to topple US economic dominance in the world.

Previously, the dominance of US megacap tech companies such as the Magnificent Seven was threatened by the rise of DeepSeek.

In contrast, the first five months of this year have seen the best opening five months for European stocks.

The sentiment of investors has been significantly affected by Trump's various policy announcements and tariffs, according to James Mackreides, co-manager of Fidelity European Trust (LON:FEV). "At the beginning of the year, we saw significant passive inflows into Europe at the expense of the US, but tariffs have created a great deal of uncertainty, especially as markets expect both the US and China's economies to slow down.

Many European stocks are currently significantly undervalued in relation to their US counterparts, despite these factors. According to a number of fund managers, this is the ideal time to purchase European stocks and funds because they anticipate strong tailwinds that will further strengthen European businesses in the months ahead.

Why are European stocks doing better this year than US stocks?

While the general pessimism about US stocks has undoubtedly contributed to a capital flight from the US, there is more to the relatively strong performance of European stocks through the end of May.

The manager of Montanaro European Smaller Companies Trust (LON:MTE), George Cooke, stated that for many years, capital flows were mainly one-way: from Europe into the US.

Nonetheless, investors are now reevaluating the geographic concentration of their portfolios due to the Trump administration's renewed protectionist rhetoric, which includes the imposition of tariffs on important trading partners and the threat of further escalation.

On their own, however, European stocks are arguably at their highest level in years. Paradoxically, this is partially due to Trump's policy agenda's unforeseen repercussions: "the shift in US policies regarding security and trade have potentially given Europe a wake-up call that will result in greater unity and policy coordination across the continent," Stotzel stated.

One example of this is the rise in European defense expenditures. Plans to spend an additional 500 billion on defense and infrastructure over the next ten years were approved by the German parliament in March.

Jules Bloch, co-manager of JPMorgan European Discovery Trust (LON:JEDT), added, "That's an absolute game-changer."

This is a significant shift, and the majority of the funds will be used within Europe.

European stocks are beginning from historically low valuations, particularly when compared to their US counterparts, due to the years of capital flows from Europe to the US that preceded the current setup.

Bloch clarified that European stocks, especially small-caps, are close to their lowest levels by the same metric, while US stocks, even if the tech megacap outliers are excluded, are currently trading at the top end of their historical valuations as determined by historical price to earnings (P/E) ratios.

He claimed that Europe was trading at the biggest discount to the US in a very long time.

Which industries might yield the highest returns for European stocks?

Given the extra discounts they are trading at in comparison to their large-cap counterparts, Bloch thinks European small-cap stocks are in the best position to profit from any future spike in the European stock markets.

He said, "We think the time has come for European small caps to catch up, and we know from history that outperformance comes in cycles."

In his opinion, this process could be accelerated by events such as the German financial stimulus, particularly since small-cap firms are typically the most closely linked to their home market in terms of revenue: 58 percent of European small-cap revenue originates from within Europe, compared to 31 percent for large-caps.

The industry most obviously benefits directly from the geopolitical environment of the Trump administration is defense.

Stotzel addressed the AIC webinar, saying, "A kick in the backside still moves you forward," in reference to the US withdrawing from ensuring European security under Trump.

It was unimaginable six months ago that things like the lifting of the German fiscal debt brake would occur. Six months ago it was unimaginable that Germany would spend more than 3% of its GDP on defense, possibly dragging the rest of Europe along with it.

Three investment trusts that provide exposure to stocks in Europe.

The three fund managers all support somewhat different strategies for European stock investing.

"An asset class with exceptional long-term growth potential, amazing Alpha creation, opportunity trading at various factor valuations, and which should massively benefit from the German stimulus" is how Bloch characterizes the European small-cap stocks that JEDT invests in.

The trust has no restrictions on the nations or industries in which it can invest; in Bloch's words, "we just invest in the stocks that we believe have the highest potential for outstanding returns." This is in addition to its European (previously UK) small cap focus.

MTE also focuses on small-cap stocks and thoroughly evaluates them for growth and quality characteristics.

"We like established companies that have barriers to entry," Cooke stated. "We prefer that they have high UP, R&D, excellent pricing power, recurring revenues, and other quality features. "We are growth investors as well as quality investors, and we like that growth to come primarily from self-funded, organic growth," he continues, adding that the companies must also be expanding.

Bottom-up stock selection is another foundational element of FEV's strategy; for Stotzel and the team, this means "not taking a call on things like interest rates, currencies, factors like value versus growth." There is also a specific long-term strategy that considers a minimum holding period of five years when choosing investments.

According to Stotzel, the trust also adopts a conservative stance: "capital preservation is really one, two, and three."