European stocks are outperforming their US counterparts.

European stocks have surged in recent weeks, thanks to positive economic data from China and falling energy prices. Inflationary pressures appear to be easing, which has boosted investor confidence.

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European stock indexes have been outperforming in recent months, with the DAX in Germany and the CAC 40 in France both rising by 18% or more in the last three months. This is more than double the 6.9% gain for the S&P 500. The UK's benchmark FTSE 100 has also surged, and is now just 2% away from reaching a record high.
The change in investor sentiment towards Europe highlights how much economic expectations have changed in recent months. Only a few months ago, Europe was facing concerns over the war in Ukraine, a possible energy crisis and record-high inflation. While those issues have not completely disappeared, investors have become more comfortable investing in the continent.

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The beginning of a new year has not diminished optimism among European investors, who have seen year-to-date gains that exceed those in the United States. In a sign of confidence, traders have recently poured their largest two-week sum into U.K. stock funds since June. According to fund-flow tracker EPFR, investors added more than $188 million on a net basis to U.K. mutual and exchange-traded funds in the period ended Wednesday.

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Meanwhile, the mood in the European futures market has become more optimistic, according to Chris Montagu from Citi Research. Last week, investors increased their bullish bets on European indexes to a greater extent than on U.S. indexes.

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European stocks have been surprisingly resilient in recent months, according to Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown. Despite ongoing economic uncertainty, European stocks have held up relatively well, indicating that investors remain confident in the long-term prospects of the region.
There are both mechanical and fundamental reasons for Europe's strong rebound. Compared to the United States, European stock indexes are not dominated by the same large technology stocks that have pulled the US market down. In a higher interest rate environment, investors' preference for value stocks - such as banks, retailers and energy companies - has helped cyclically tilted European indexes.

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Last year's prolonged weakness in the euro and the British pound against the dollar made European stocks more attractive to some investors. Additionally, it was a boon to European companies that derive a large portion of their revenues from overseas. A weaker euro and pound increases European companies' export competitiveness and the value of their dollar-based revenues.

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The euro and the pound have both seen positive movements in recent weeks, driven in part by growing optimism for the region. This has been beneficial for dollar-based investors, who have seen their returns improve as a result.

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European stock markets have been bolstered by a stronger economic backdrop. A warmer-than-expected winter has alleviated investor concerns that an energy crisis could derail the economy. Falling energy prices have also helped bring inflation down. Last week, data from the European Union’s statistics agency showed that the annual rate of inflation eased in December for the second consecutive month, with consumer prices rising at their slowest pace since August. Inflation is also slowing in the U.K.

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The recent loosening of China's Covid-19 restrictions has given a boost to some European stocks, including miners and luxury retailers. For example, luxury goods giant LVMH Moët Hennessy Louis Vuitton SE and Birkin-bag maker Hermès International SCA have each climbed around 10% this year on the expectation that Chinese consumers will increase spending overseas.

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According to Florian Ielpo, head of macro at Lombard Odier Investment Managers, there is a stronger connection between European stocks and China than with U.S. stocks.

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Mr. Ielpo said that he wasn't optimistic about the outlook for Europe. He believes that the European Central Bank is still in the early stages of its tightening cycle, and that therefore more pain is likely awaiting European economies as borrowing costs rise. The long-term support that China's reopening can bring to European companies is "a big question mark," he said.

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"In the short term, there are a number of positive factors that have been benefiting European stocks," Mr. Ielpo said. "However, in the long run, these factors are likely to fade."

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Another question is whether traders’ current preference for value stocks will persist. If technology stocks rebound at some point in 2023, that could reduce the appeal of European markets.

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"It's still too early to say for sure," said Kevin Gardiner, global investment strategist at Rothschild & Co. Wealth Management. He added that his overall view is still more positive on U.S. assets than those in Europe. "It's still early days, and we haven't seen a peak in interest rates yet," he said. "We can't be confident about whether there will be a global recession in 2023 or not."