Europe funds review – what do frozen interest rates mean for markets?

US stock markets have dominated headlines and investment portfolios in recent years. But this year, the spotlight has shifted towards Europe.

Both private investors and bigger institutions have been investing more in the continent. Like New Zealand’s Super Fund, one of the world’s best-performing sovereign wealth funds, which has increased its stake in European shares while trimming its US allocation.

This is partly because European shares have been trading at a discount to other markets, particularly the US. As concerns over economic growth, inflation and the labour market have been rising in the US, investors have been turning their attention to markets offering greater value.

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Andrew Birt

Senior Cross Asset Strategist

This article isn’t personal advice. If you're not sure if an investment is right for you, ask for financial advice. All investments fall as well as rise in value, so you could get back less than you invest.

Political change in France, but markets hold steady

There is still political uncertainty in Europe, despite its market returning to form this year. Most recently in France, Prime Minister François Bayrou’s government lost a crucial parliamentary vote, leading to his resignation. President Macron swiftly appointed defence minister Sebastien Lecornu as the new prime minister.

Lecornu faces the immediate challenge of managing a fragile budget situation, with France’s budget deficit standing at 5.8% of GDP last year.

Two main scenarios could be on the table – either the new government successfully negotiates a budget that reduces the deficit, or it doesn’t, leading to a rollover of the existing budget framework and a stable or slightly higher deficit.

Financial markets have so far reacted modestly. French 10-year bond yields have edged up but remain around 3.5%, which, given the current economic environment, doesn’t signal alarm. The euro has also remained stable. That said, the country remains vulnerable to political shifts and market sentiment.

France’s political backdrop also won’t necessarily derail broader interest in European shares. That’s partly because political risk isn’t what drives markets over the long run.

The companies in France’s CAC 40, for example, make just 20% of their revenues domestically. The rest is made internationally. And although French shares have underperformed the wider European market by 5% so far this year, weighed down by weakness in areas like luxury goods and autos, domestic-facing sectors like insurance and banking have held up well.

European interest rates on hold

The European Central Bank (ECB) kept interest rates on hold at 2% during its latest meeting in September. This wasn’t a big surprise, as inflation across the eurozone has been coming down gradually, and the ECB wants to avoid putting extra pressure on the broader economy.

Further rate cuts are no longer expected this year. Partly because it gives policymakers time to understand how US tariffs, higher German government spending, and political turmoil in France might impact growth and inflation. The current expectation is that rates could move again early in 2026.

How have European stock markets performed?

While there have been difficult periods for most major stock markets over the past year, the broader European stock market, as measured by the MSCI Europe ex UK index, grew 10.18%*. This is behind the 13.16% for the MSCI AC World index, in which the US makes up a large portion, but this masks strong performance from some of Europe’s underlying markets. As always, past performance isn’t a guide to future returns.

Southern European markets have led performance over the past year, after previously being shunned by investors following the peak of the eurozone debt crisis in 2012. Greece has led the way with returns of 63.51%, while Spain and Italy have grown 44.79% and 32.50%, respectively.

Europe attracted investor attention this year after Germany announced a fiscal stimulus package and defence spending increased significantly across the continent. This helped markets like Germany’s, which has risen 27.81% over 12 months, but many investors have turned to overlooked markets in southern Europe that offer greater value.

Stronger economic growth and improved political stability in the southern region has also helped. As has the performance of banking shares, which make up a much greater portion of these countries’ markets. The financials sector makes up half of Italy’s main market, and 44% of Greece’s. Meanwhile, banks only make up 5.4% of Germany’s stock market.

Returns in the north have been more muted. It’s been a noticeably painful time for Denmark, whose stock market has lost 41.36% over one year. This has a lot to do with pharmaceutical giant Novo Nordisk’s share price falling dramatically due to downgraded growth forecasts, disappointing clinical trial outcomes, and rising competition from US firm Eli Lilly.

European smaller companies returned to form over the year, growing 14.98%. When investor sentiment improves it can benefit higher-risk smaller companies that rely more on the strength of their domestic economies for success. Share price valuations in this area of the market have also been more attractive. This has helped performance in recent months.

How have European Wealth Shortlist funds performed?

The European Wealth Shortlist funds have delivered different returns over the past year. We expect this – a range of managers with different strengths, styles and areas of focus will perform differently in different economic conditions.

Remember, past performance isn’t a guide to the future, and performance here is over a short time. All investments fall as well as rise in value, so you could get back less than you invest. Income is variable and not guaranteed.

Investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.