Europe’s economic landscape is undergoing a transformative shift, driven by substantial fiscal stimulus that promises to reshape the region’s equity markets. This according to an update from Citigroup (NYSE:C).
According to a recent Citi Research report titled European Equity Strategy: European Fiscal Stimulus Revisited, led by Head of European Equity Strategy Beata Manthey, the outlook for European fiscal stimulus is exceeding expectations, with significant implications for earnings growth, equity valuations, and investor sentiment.
This surge in government spending, particularly in Germany, alongside broader European Union (EU) commitments, is poised to drive a structural revaluation of European equities, potentially boosting the STOXX 600 index by 10-15% by the end of 2025.
The report highlights that Europe’s fiscal policy has taken a decisive turn, with larger-than-expected NATO defense commitments and accelerated German infrastructure spending leading the charge.
The EU’s Readiness EU package (formerly Re-Arm EU), allocating €800 billion (1.1% of EU GDP annually) through 2030, is set to lift gross domestic product (GDP) earlier and more significantly than previously anticipated.
Citi now projects an additional 0.4 percentage points to GDP growth in 2027, with effects potentially materializing as early as mid-2025 in Germany.
This stimulus is expected to add approximately 3% annual earnings per share (EPS) growth for European equities over the next five years, with German equities standing out as primary beneficiaries.
Germany’s stimulus plans are particularly front-loaded, with analysts revising EPS growth forecasts upward.
Consensus expectations for German equities now project a 13% compound annual growth rate (CAGR) through 2029, up from 11% earlier this year.
Citi’s models suggest an additional 2% annual EPS growth from German stimulus, culminating in a 15% CAGR and 10% higher total EPS by 2029 compared to current bottom-up forecasts.
This growth trajectory is expected to justify higher valuations, with Citi predicting a forward price-to-earnings (P/E) ratio increase for the STOXX 600 from 14 to 16 times by December 2025, driven by a 25-basis-point reduction in the equity risk premium (ERP).
The renewed appeal of European equities is also fueled by shifting global investment trends.
Year-to-date inflows into European markets have reached approximately 2% of assets under management, reflecting a diversification away from U.S. equities, which global investors have historically over-allocated to.
European households, holding only 20% of their savings in equities compared to 40% in the U.S., have significant room to increase equity allocations, particularly as Germany explores policies to boost retail investor participation.
This domestic and international capital flow could further support market revaluation.
However, the path forward is not without risks.
While the stimulus is expected to bolster sectors like infrastructure and defense, fiscal constraints in other eurozone countries may limit their ability to match Germany’s spending pace.
Citi notes that the broader eurozone’s goal of raising defense spending to 3% of GDP is ambitious, with actual expenditures likely to be smaller and more back-loaded outside Germany.
Moreover, global economic uncertainties, including potential U.S. tariff hikes and a possible slowdown, could temper growth.
Citi’s economists estimate that U.S. tariffs could reduce European EPS growth by up to 3 percentage points in 2025, potentially flattening growth if a broader economic slowdown occurs.
Despite these challenges, the contrarian buy signal from Citi’s Earnings Revision Index (ERI), which recently hit recessionary levels of -60%, suggests that European equities may be poised for a rebound.
Historically, such low ERI readings have preceded 25% returns within 12 months, particularly in cyclical sectors like autos, tech, and luxury goods.
The combination of fiscal stimulus, monetary easing by the European Central Bank (which has halved its main interest rate over the past two years), and improving investor sentiment arguably positions European equities as a potential diversification play.
In conclusion, Europe’s fiscal stimulus, led by Germany and bolstered by EU-wide initiatives, is seemingly set to drive a structural revaluation of its equity markets.
With EPS growth projections rising, valuations expanding, and capital flows increasing, the STOXX 600 could see significant upside by mid-2026.
Investors might want to monitor these developments closely, as Europe’s equity markets may finally be shedding their post-financial-crisis underperformance.