In recent years, U.S. equities have outperformed other regions, driven largely by valuation expansion and strong earnings growth. U.S. earnings growth over the last 30-years has been significantly driven by expanding profit margins in the technology sector. An appreciation of the U.S. dollar also contributed to the relative outperformance versus European equities. This success has led many investors to overlook the potential of European equities which have lived in the shadow of their more exciting U.S. counterparts. But, as global markets enter a new phase defined by higher rates, high tariffs and shifting supply chains, Europe is emerging as an asset class that should not be ignored, within the context of a sound and globally diversified investment portfolio.

The case for European equities

While U.S. investors often express skepticism about low valuations in international markets, we at Vanguard see European equities as attractively priced. The common perception that European equities are cheap for a reason—citing geopolitics, tariff concerns, and limited exposure to AI growth—does not fully account for the broader investment landscape. Our analysis suggests that European equities are poised for strong performance over the next decade.

We maintain a particularly optimistic outlook for European equities over the next decade. Based on our projections¹, European equities are expected to outperform Global ex-Euro area equities and U.S. equities for Canadian investors over the next 10 years. This optimism is partly rooted in the belief that European equities offer a strong value tilt, which we see as more favorable compared to the growth-driven U.S. market dominated by large-cap firms like the mag 7. Value stocks traditionally have higher payout ratios and that is predicted to be the highest contributor to ex-U.S. outperformance.

Other reasons to invest in value and international stocks is artificial intelligence (AI). If AI proves to be a transformative technology with broad economic benefits, its impact is likely to extend beyond the technology sector into industries such as health care, finance, and manufacturing. Historically, transformational technologies like electricity have reshaped entire economies, not just the sectors directly involved. Electricity, for example, boosted productivity across a wide range of industries and regions, including those outside the United States.

Another compelling reason to invest in European equities is the evolving earnings outlook. While Vanguard continues to project higher earnings growth in the U.S. compared to other regions, its expectations are more conservative than the strong performance seen over the past decade. This suggests a potentially more muted effect on long-term returns, making international diversification, particularly in Europe, an attractive strategy.

Additionally, currency dynamics have played a significant role in relative performance. A strong U.S. dollar had previously dampened international equity returns for Canadian investors when compared to U.S. equities. However, this trend began to reverse in early 2025, with the dollar weakening toward fair value. Looking ahead, we do not expect the U.S. dollar to maintain its previous strength over the next decade, which could further support the case for international investments.

Overall, we believe the last decade of U.S. outperformance is likely sowing the seeds for the next decade of underperformance; the valuation-driven outperformance of U.S. equities is unsustainable.

Sector diversification

Europe’s equity markets are also structurally different from those in North America and other parts of the world. One of the standout benefits of investing in European equities is the opportunity for sector diversification. Unlike the U.S. market, which is heavily concentrated in technology and large-cap growth stocks, Europe offers a strong value orientation with significant exposure to sectors such as healthcare, financials, and industrials.

Moreover, European markets provide access to globally recognized luxury brands, including LVMH (France), Richemont (Switzerland), and Ferrari (Italy), adding a unique dimension to portfolio diversification. This value tilt is particularly attractive for investors seeking higher dividend yields and potentially stronger risk-adjusted returns.

Vanguard’s European Equity ETF (VE) reflects this philosophy, offering broad exposure to a diverse array of companies across 16 countries, helping investors tap into the full breadth of opportunities within the European market.

Portfolio construction with VE

Vanguard's European Equity ETF (VE) stands out in the Canadian market for its market-cap weighted approach, which is relatively unique. Many other European Equity ETFs focus on yield or leverage, but VE offers a balanced and comprehensive exposure to the European market. This all-cap approach not only gives investors access to smaller, potentially undervalued firms but also ensures better diversification, as the companies are not all highly correlated. VE’s FTSE GEIS master benchmark provides access to 98% of the  investible market, thanks to its benchmark, providing access to a wide array of European companies that we view as more attractive from a valuation perspective. This makes VE an excellent tool for investors looking to diversify their portfolios and potentially reduce total portfolio volatility.

How Much European Equity Exposure is Enough?

We recommend a modest overweight to European and ex-North American equities within our model portfolios and time-varying asset allocation strategies. This positioning reflects our view that these markets are relatively undervalued and offer improved earnings growth potential compared to recent history.

It’s important to note that investors who deviate from market-cap-weighted portfolios should be prepared to tolerate periods of relative underperformance or outperformance. Such deviations require both the ability and willingness to stay invested through varying market conditions in pursuit of long-term benefits.

Market Trends

European equities have experienced significant inflows in 2025, signaling renewed investor interest in the region. As of July 31, year-to-date (YTD) flows reached $476 million, already far surpassing the $287 million recorded for the entire calendar year of 2024.

A major contributor to this trend has been our Vanguard European Equity ETF (VE), which offers broad, diversified exposure to attractively valued European companies. VE saw $156 million in YTD flows as of July 31, 2025, an over 7x increase compared to the $21 million in flows during all of 2024. This surge highlights growing investor confidence in European markets and the appeal of VE’s diversified, value-oriented portfolio.

Conclusion

Investing in European equities can offer meaningful diversification benefits to a balanced portfolio, providing exposure to a broad mix of industries, currencies, and a strong value-oriented sector. Vanguard’s European Equity ETF (VE) is a market-cap-weighted fund that tracks a benchmark covering 98% of the investable European market, making it a compelling option for investors seeking to capitalize on the region’s relative undervaluation.

For investors with the ability to tolerate short-term volatility, we recommend a modest overweight to European equities. This aligns with our long-term constructive outlook for the region, supported by improving earnings potential, relatively high dividend yield and attractive valuations.

Europe has often been treated as an afterthought by investors. But it offers attractive potential for investors with attractive valuations, reliable income and strong fundamentals. For investors willing to look beyond the familiar, Europe is poised to reward their patience.

¹Vanguard Capital Markets Model (VCMM) as at June 30,2025