Is there a war discount in Europe?

Good morning. President Donald Trump has instructed his advisers to draw up a set of “reciprocal” tariffs on America’s trade partners. These would be an effort to respond, on a country-by-country basis, to trade barriers faced by US exporters abroad. This will be a complicated endeavour, but if Trump follows through, the tariffs can be a much bigger deal than the other measures threatened to date. You can read Unhedged’s interview with reciprocity fanboy and National Economic Council director Kevin Hassett here; you can read Financial Times trade guru Alan Beattie on reciprocity here; and you can hear Alan discuss reciprocity on the Unhedged podcast here. You can also reciprocate by emailing me at robert.armstrong@ft.com. 

Ukraine and European markets

News that Trump and his Russian counterpart Vladimir Putin spoke on the phone, and Trump saying that Ukraine peace negotiations would start at once, moved markets yesterday. European stocks rose, especially in energy-dependent sectors like chemicals. The Euro strengthened against the dollar, despite a hot US inflation report the day before. European sovereign interest rates fell. Brent crude prices dropped, and European natural gas prices dropped a lot. Russian assets popped. 

All of this needs to be kept in perspective, though. Outside of natural gas (down 8 per cent) and a few gas-sensitive securities (German chemicals group BASF rose 5 per cent) the moves were incremental. The German and French equity indices’ move was just another notch in what has already been a brisk rally in 2025:

The move in Brent crude prices was a tiny blip amid recent volatility:

Even so, if a mere phone call between a notoriously unpredictable president and a notoriously Machiavellian one can move markets at all, that would seem to imply that the stakes are high. How big would the move in European assets be, were peace actually achieved?

One of the biggest topics in markets in the years since Russia’s full-scale invasion of Ukraine has been “American exceptionalism”, the widening performance and valuation gap between US assets and their peers all over the world. European assets are often the primary contrast class in these discussions. And it is natural to think that the war in Ukraine has contributed to Europe’s weak showing. 

Several sell-side analysts have taken this view. Here, for example, is Joachim Klement of Panmure Liberum:

An end to the war in Ukraine increases the likelihood of our Goldilocks risk scenario for 2025 because it could significantly reduce inflation pressures, allowing central banks to cut interest rates faster and stimulate the economy. The main beneficiaries would be airline stocks, chemicals companies and other energy-intensive industries.

And here is Emmanuel Cau of Barclays, writing before the Trump-Putin call:

A significant ‘war risk premium’ remains across EU markets. EUR/USD is 10 per cent below its pre-Ukraine invasion level, while the cost of the war has inflated EU government deficits and fuelled stagflation across Europe, resulting in weaker growth and higher bond yields. So any progress towards a pause in the conflict may been seen as likely to ease the fiscal and economic burden on the region, in our view. 

Cau notes that EU manufacturing surveys have never recovered to their pre-invasion levels, and the gap between European and US energy prices, while it has narrowed in the past year and a half, is still 20 per cent wider than it was before the war. 

All of this is true, but anyone expecting a wholesale revaluation of European equities, should a lasting peace be achieved, is likely to be disappointed. In February of 2022, at the moment of the invasion, the valuation discount of European stocks was 27 per cent. Now it is 37 per cent. How much of that increase is the war overhang? Possibly none. Japanese stocks, for example, have seen their discount to American stocks expand by exactly the same amount. 

Here is another way to look at it. One of the more energy-sensitive sectors of any economy is industrials. Here is the stock performance of US and European large-cap industrials since the invasion:

They are the same. And over this time, European industrials’ valuations have actually weakened a bit relative to their US competitors, implying that their returns have kept pace because European earnings have grown faster.

This suggests that it is not war overhang, but rather a familiar story — the wild rally in US tech shares — that has cemented American exceptionalism in stock markets since 2022. 

There is another issue to be considered before betting on a European risk rally following a peace deal. In order for European growth and profitability to take off, a peace deal needs to do more than get Russian gas flowing into Europe again. It needs to provide reassurance that peace will hold.

Policy analyst Andrew Bishop of Signum has noted that he was surprised by “the degree to which President Trump seems to have been willing to sideline Ukraine and make it a mere price-taker in its own destiny.” Bishop has increased his odds of a peace deal in the first half of this year (from 25 to 35 per cent) because Trump might give Putin at the negotiating table what Putin wants on the battlefield. That is: the Ukrainian territory Russia has stolen, along with relatively weak security guarantees to restrain Russia from further adventures on its western border. If European markets are weighed down by a war discount, a frail peace bought on the cheap is unlikely to lighten it. 

One good read

Late bloomers (Inexplicably, no reference to the famous American journalist who took up the trade at 37).

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