Europe is cheaper than America, but no longer cheap

The discount is no longer evidence of cheapness

European equities gained 12% in the first half of 2026, slightly ahead of the 10% US rise. By June, price-to-earnings ratios in both regions had recovered above their historical averages, according to ESMA. Europe therefore remains cheaper than America, but it is no longer obviously cheap against its own history.

That distinction matters because a headline index multiple mixes businesses with very different economics. It does not adjust for sector weights, returns on capital, reinvestment opportunities or the durability of earnings. A lower multiple can represent mispricing, but it can also be the correct price for a slower and more cyclical stream of cash flows.

Two indices with different economics

The composition gap is substantial. Among non-financial companies on main markets, technology represented 43% of US capitalisation at the end of 2023. Europe’s largest sector was consumer cyclicals at 18%, according to the OECD. The US index consequently contains more asset-light companies whose margins and addressable markets can expand without equivalent growth in physical capital. Europe contains more banks, industrial companies, energy exposure and mature consumer franchises.

The profitability gap is not merely statistical. An IMF firm-level study found that productivity at listed European technology firms declined at an annualised 0.3% over the period studied, while US peers grew by 1.5%. European technology companies spent roughly 3% to 4% of sales on research and development in 2023, against 12% in the United States. A persistent difference in innovation and reinvestment justifies some premium for the market that can compound earnings faster.

The quality of the rerating is uneven

Europe’s strongest rerating has nevertheless been supported by real changes. Bank shares rose 53% in the year to June 2026, compared with 19% for European non-financials. The ECB attributes the earlier rise in bank price-to-book ratios to higher short-term rates, improved profitability and larger payouts. Its model finds valuations broadly consistent with fundamentals and says the remaining gap with US banks mostly reflects weaker macroeconomic conditions, rather than inferior bank fundamentals.

This is evidence that part of the old discount was excessive. It does not mean that all of the new earnings deserve a higher multiple. Bank income remains exposed to deposit pricing, credit costs and the rate cycle, while industrial and defence earnings depend more heavily on public budgets, order conversion and working capital. Quality should therefore be tested through cash conversion, return on incremental capital and the share of growth that survives normalised rates and commodity prices.

The US premium is not wholly a quality premium either. ESMA says its 2026 rise was powered by strong technology earnings, but also warns that market concentration and circular financing around artificial intelligence have made the index increasingly dependent on continued spending. Richer businesses can still carry richer expectations than their cash flows ultimately support.

Flows do not yet prove a structural turn

Early 2026 brought stronger inflows into European and other advanced-economy equity funds than into US funds, according to the Bank for International Settlements. The longer record is less decisive. Euro-area investors quadrupled their US equity holdings between 2015 and 2025. The ECB calculates that 70% of that increase came from valuation gains and 30% from net purchases.

The recent rotation can support a rerating without establishing a permanent European cost-of-capital advantage. A structural change would require sustained domestic equity allocation, deeper cross-border markets and more listed firms able to reinvest at high returns. Until then, Europe is better described as a market with pockets of repaired profitability and selective value, rather than one broad bargain. Its remaining discount is partly outdated, partly earned and increasingly dependent on what sits beneath the index.

Sources

1. European Securities and Markets Authority, TRV Risk Monitor No. 2, 2026, 10 September 2026.
2. OECD, Equity Markets for Growth Companies, September 2025.
3. IMF, Europe’s Productivity Weakness: Firm-Level Roots and Remedies, March 2025.
4. European Central Bank, The drivers of the 2025 surge in euro area banks’ market valuations, May 2026.
5. Bank for International Settlements, Markets recalibrate amid shifting currents, March 2026.
6. European Central Bank, Drivers of investor behaviour in highly valued equity markets, May 2026.