The Jackson Hole reprieve
The outcome of Jackson Hole provided welcome relief for US investors, as Fed Chair Jerome Powell signalled his most dovish stance to date, and the probability of a September rate cut now rising to 85%. The VIX has remained relatively subdued since its April high (see Figure 1), and notably, the equal-weighted S&P 500 recently reached a new all-time high. Until now, the US rally had been driven primarily by the Magnificent Seven and concentrated optimism around AI. The equal-weighted breakout indicates that the other 493 large-cap stocks in the S&P index are beginning to participate as well.
Figure 1 – The VIX remains relatively subdued; however, investors are pricing a healthy level of cynicism
Economic and political pressure: A double-edged sword for the Federal Reserve
The subtle shift in Chair Powell’s stance toward potential rate cuts, coupled with his imminent departure as Fed Chair, stands out against the backdrop of the recent tensions between the Fed and the White House. While the targeted pressures that the Fed have faced are atypical, including efforts to remove Board member Lisa Cook, it is not unprecedented. The events mirror several past presidents attempting to influence monetary policy. A politically influenced Fed could likely place greater emphasis on employment than on price stability, which would drive long-term yields higher through upward biased inflation expectations and a steeper term premium. All else equal, this would reduce the central bank’s ability to regulate the economy. It is cautioned that even limited White House influence on Fed policy could prove disruptive and carry significant economic costs irrespective of political objectives.
At the same time, Powell’s inclination to lower the US policy rate is not without its economic validation. As noted in our prior Market Synopsis, US economic data have gradually aligned with the more pessimistic signals from consumer soft data. Most recently, the first estimate of second-quarter real GDP showed growth slowing to 1.5%, following 1.6% in the first quarter of 2025. Year-to-date GDP growth is therefore not far from the average pace of 2022, a period similarly marked by widespread recession concerns – see Figure 2.
Figure 2 – US real GDP in 2025 so far mirrors 2022 lows
Looking back on 65 years of data, recessions have typically occurred whenever year-over-year nonfarm payroll growth falls below 1%. As of the July employment report, the indicator is walking a tightrope with May-through-to-July readings of 1.03%, 0.98% and 0.97%, respectively – see Figure 3. The question remains whether a September rate cut would be too little too late, or further fuel for inflation given how uncompromised AI-linked investment has been throughout the last twelve months.
Figure 3 – US non-farm payrolls are teasing the recession-signal threshold
Does European equity look attractive?
Referring to Figure 4, European equities have historically unperformed their US counterpart by a cumulative 220% since 2007. This is until 2025, of course. Year-to-date, the relative gain is admittedly modest, at 3% in dollar-currency terms. However, on a common currency basis, this rises to 16%.
Figure 4 – US equities remain the undisputed winner in the global post-GFC regime
The AI/tech trade has proven itself as insulated against economic woes thus far, with AI investment remaining uncorrelated to the stumbles in US consumption and employment. Even more so, the AI rally is solely to thank for dragging the rest of the US market along this year, closing the even greater return differential that European equities enjoyed mere months ago. We can confirm this when viewing how concentrated the US equity market has become compared to other developed countries – see Figure 5.
Figure 5 – Concentration is becoming a near-structural component of the US market
Focusing on fundamentals, Europe has consistently had cheap relative valuations for over a decade, plagued by various structural pitfalls; fragmented and shallow markets were the norm across the Eurozone – see Figure 6. The greatest dampening on Europe’s potential growth came in the aftermath of the Global Financial Crisis (“GFC”), in the form of fiscal austerity.
Figure 6 – Valuation differentials between the US and EU have radically diverged across all sectors
European Austerity versus US Profligacy: The long-run implications
While the US began an almost unbounded regime of fiscal spending (a trend it has continued until today), EU countries instead dramatically cut government spending – see Figure 7, top panel. Following 13 years of profligacy, the US has a cumulative primary fiscal deficit (as a % of GDP) that overshadows the EU’s deficit by more than a multiple of three. The contrast of the austerity chosen by European nations was not necessarily an incorrect decision; the cuts aimed to reduce the deficits that governments faced, and stabilise borrowing costs, amongst several other objectives. Germany was amongst the most aggressive of the EU, limiting structural deficits to only 0.35% of GDP – a significant headwind for equity performance. However, what we have seen as a result is that the interest costs of the US government have ballooned versus the Euro area – see the bottom panel of Figure 7.
Figure 7 – The US deficit has consistently grown since 2012, along with the government’s debt-servicing costs
Right now, the policy differential between the US and EU appears to be reaching a turning point. The advent of a pandemic, energy crisis, wars, and trade tensions has supported the need for the EU to reverse its fiscal policy. Germany is leading the charge in this shift, finally lifting the debt brake, and committing €1 trillion across defence and infrastructure. Alongside the end of European austerity, the prolonged regime of private sector de-leveraging looks to also be reaching a turning point. European banks struggled in the post-GFC environment, as nonperforming loans exploded and the ECB brought about negative rates. Private debt has now seen a consistent decline as a percentage of GDP since 2008 (Figure 8 – top panel), and lenders, with the exception of France, all sit in a far more comfortable position in terms of their debt-service ratios (Figure 8 – bottom panel).
Figure 8 – European private lending has structurally deleveraged over the same period as US profligacy
With loan risk as a fading threat, capital and liquidity ratios have strengthened. Given that European banks account for 70% of private lending in the zone (versus US banks at only 25% of total US lending), it is not surprising to consider the outperformance of European-domiciled banks since 2022 – see Figure 9. If we refer back to Figure 3’s bottom panel, we can note that despite this rally, the banks are still sitting at close to a 40% discount to their US counterparts, in terms of forward P/E multiples.
Figure 9 – Euro banks have enjoyed the repricing of their stronger capital positions
Ultimately, sentiment towards the EU are at relative highs, with European fiscal policy flexible enough to lean accommodative going forward. The US, by contrast, will ultimately be forced to step back from its fiscal profligacy soon. President Trump’s “One Big Beautiful Bill Act,” combined with higher tariffs, is set to create a near-term fiscal drag. The US fiscal outlook may become far weaker than it was between 2016-2024 and consequently shift from being a historically supportive tailwind to a future headwind for the economy instead. In the event of the US economy falling from its tightrope and triggering a widespread economic downturn, the valuation gap in European equities stand to offer materially more downside protection, all else equal.
Investment takeaway
European equities are becoming more appealing compared to the US from a fundamental perspective. Valuations remain low across sectors, and the calming of several structural headwinds are supporting the outlook. In the wake of a more dovish Fed going forward, the direction of the US government’s fiscal policy will now become a key point in the investment decision for US equities.
If you are interested in finding out more about how cognisance of the macroeconomic backdrop impacts our investment decision making process, connect with Integrity Asset Management and let us help you navigate your investing journey.
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Source: Bloomberg, 29 August 2025