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If you’ve ever been an underdog, you know it can be tough. But underdogs have a special power. As the saying goes, “Being the underdog means no one sees you coming until it’s too late.”

That’s the story of European stocks.

While European stocks have posted impressive gains at times during the last decade, U.S. large-cap stocks, driven by the Magnificent 7, have risen a lot more. The cumulative gain of U.S. large-cap stocks has been three times that of European stocks in the past 10 years.

This year, European stocks have seized the crown. The MSCI Europe Index has gained 24.0% year to date while the S&P 500 is up 6.2%.��

At 2024 year-end, who expected European stocks to stage a coup while the S&P 500 sat so firmly on its throne amid a post-election rally? That’s the power of an underdog.

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This is a big deal

Europe’s stock performance is a big deal for several reasons.

The most obvious being that it pays to have a portfolio that’s diversified, not just across asset classes, but geographies. No matter how sophisticated an investor you are, you never know for sure what asset class is going to lead from year to year.

European stocks have gained real momentum in recent years (for example, in 2017, 2019 and 2023). However, this is the best first half of the year performance for the MSCI Europe Index relative to the S&P 500 since MSCI Europe’s 1986 inception.

Here's another reason this is a big deal: European stocks could continue to be a larger force in the global market beyond 2025.

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A currency-juiced rally

This year’s outperformance by European stocks versus the U.S. is as much a currency story as it is a stocks story.

A steep decline in the U.S. dollar against the euro and other major currencies is playing a big role in relative European stock returns in 2025.

The decline in the U.S. dollar accounts for more than 60% of the gain of the MSCI Europe Index in U.S. dollar terms.

So, why has the U.S. dollar fallen so much? After all, the U.S. dollar is the world’s chief reserve currency held by major central banks. Two factors in particular have conspired to make the U.S. dollar assets less attractive this year: 1) A renewed focus on our rising fiscal debt has undermined U.S. creditworthiness and 2) Uncertainty around U.S. tariff policy.

But as we have mentioned, we don’t think the U.S. dollar will relinquish its status as the global reserve currency any time soon.

The larger point is that different currencies and stock markets do better at different times, so wide exposure to them all can help a portfolio.

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Europe has its own attributes

The emergence of European stocks is not just about relative U.S. weakness this year.

After years of struggle, Europe’s investment fundamentals appear to be strengthening, with the region benefitting from both fiscal and monetary tailwinds.

Germany, Europe’s largest economy, plans a substantial increase in fiscal spending, which could benefit its neighboring countries given its regional influence.

Like the U.S., Germany has a new government, and it has ambitious plans across its economic sectors, including infrastructure and healthcare. Also, the European Union bloc of countries has proposed a major lift in defense spending following Russia’s invasion of Ukraine.

Meanwhile, the European Central Bank has been cutting its key interest rates (eight times since June 2024), which will make it cheaper for companies to borrow and grow. The ECB expects an increasing Gross Domestic Product growth rate for the eurozone over the next couple of years. All this signals greater company output and profits.

Indeed, earnings estimates have been rising for European companies while their stock valuations appear much cheaper than U.S. large-cap stocks after years of U.S. outperformance.

Widening our lens, the European Union is also in better fiscal shape when comparing its percentage of public debt to overall GDP: 81% versus 100% for the U.S. (and that U.S. figure could rise substantially if the tax and spending bill passes in its current state).

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Opportunities beyond technology

Given the region’s expected spending plans and economic growth, it shouldn’t be too surprising that industrials and financials are among the sectors driving European stock returns this year. Financials and industrials are also the biggest sector weights of the MSCI Europe Index, comprising 22.7% and 18.5% of the index, respectively.

In contrast, those sector weights are 14.3% and 8.7%, respectively, in the S&P 500. Yet, the S&P 500’s information technology weighting (think the Magnificent 7) is a whopping 31.6% of the index while it’s just 7.3% of MSCI Europe.

What’s the takeaway here?

The European stock market is driven by its own set of fundamentals that operate on a trajectory separate from the U.S. and provides powerful diversification from U.S. exposure. How good do you feel if you entered 2025 with a European stock allocation?

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It's a big world

Still, make no mistake – the U.S. remains the world’s leading economy, and it’s a hotbed of innovation and world-class investments. Another thing: the U.S. stock market has proven to be remarkably resilient.

That said, if your portfolio’s allocations aren’t being professionally managed and rebalanced, your allocations may have become too concentrated in U.S. stocks after years of U.S. outperformance.

The U.S. equity market represents 47.4% of the $130.4 trillion in global equity market cap. That leaves more than 50% of the world’s equity market where underdogs may lie in wait. Why rob your portfolio of that diversification, especially in a world where shocks can hit different regions at different times?��