Global Market Strategist
In Brief
- European equities look more attractive as low valuations are now supported by improving earnings momentum, rising margins, stronger Purchasing Managers' Index (PMI) and broader sector participation.
- Key growth drivers include infrastructure, fiscal spending on defense and energy security, and accelerating bank lending.
- Europe offers diversification beyond U.S. tech, with opportunities in banks, industrials, capital goods, defense, renewables and energy infrastructure.
European equities look increasingly attractive because the investment case has moved beyond the familiar argument that the region is simply cheap. Valuations remain relatively low, but that has been true for years. What is different now is that earnings momentum is improving, corporate margins are rising, PMIs are moving into expansion, and Europe is becoming more exposed to multi-year investment themes such as infrastructure, defense, energy security and fiscal spending. For investors seeking diversification beyond the U.S. technology-led market, Europe now offers a more credible mix of valuation support, earnings growth and sector breadth.
Backdrop looking up
The backdrop for European equities is constructive, supported by positive EPS revisions, consecutive months of rising Eurozone PMI readings, improving credit growth and broader market participation. This is good news because Europe has often looked inexpensive without delivering sustained outperformance. Today, the valuation discount is being accompanied by better fundamentals.
We see three main engines supporting the market. The first is AI and data-centre capital expenditure. Europe may not dominate the global AI software story, but it is strongly exposed to the physical infrastructure behind it in the form of power grids, cooling, semiconductors, electrical equipment, automation and industrial components. That should mean investment support for industrials, capital goods, utilities and energy infrastructure.
The second engine is fiscal spending. Governments are allocating more capital toward defense, energy security, grid modernisation and strategic independence, especially in the face of uncertain geopolitics. We are beginning to see announcements of longer agreements in production, away from one-off contracts that are susceptible to short-term sensitivity and toward a longer-duration public and private capex cycle.
The third is improving loan growth. European banks are lending into an early corporate re-leveraging cycle, with loan growth accelerating to above 4.0% year-over-year, suggesting improving confidence in investment, hiring and corporate activity.
The economic cycle appears to be broadening. The Manufacturing PMI new orders subindex looks to be finally breaking out of its 4-year long doldrum of being below 50 and looks to be heading for a new positive cycle and should be supportive of earnings, as seen in Exhibit 1.
This is already reflected in the earnings estimates. Consensus EPS growth is projected at nearly 20% for 2026 and above 10% for 2027. Forecasts always require caution, but these estimates appear more credible than in prior years because they are supported by positive revisions, better PMIs and broader sector participation. European corporate margins are also rising strongly, led by banks and areas affected by oil and commodity prices, contributing to one of the strongest quarterly earnings seasons in almost four years.
An important point to consider is how Europe also offers diversification away from the U.S. technology trade. Over the past few years, U.S. earnings growth outpaced the rest of the world, helped by mega-cap tech stocks and AI-related companies. This year, this behaviour looks like it has started to reverse as earnings outside the U.S. improve. AI remains a hugely exciting theme, but it may not dominate equity returns to the same extent as before. Europe’s revenues are balanced between domestic and global exposure, enabling companies to benefit from domestic recovery while maintaining global growth participation. Because Europe is a mature, low-growth economy, the earnings opportunity does not require a major GDP acceleration. Improvements in activity, margins, and operating leverage can still drive attractive earnings growth. Europe offers exposure to themes that are linked to infrastructure, power and automation, while also benefiting from areas that are less correlated with AI, such as banks, renewables and defense.
Sectors to benefit
At the sector level, banks are one of the strongest supports for the regional market with a favourable environment of ECB rates below 3%, lending momentum and strong capital markets activity. The MSCI Europe Bank industry group has outperformed the broader European market by around 15% and is almost even with the S&P 500 tech sector year-to-date in local currency price terms. Since the start of 2025, it has outperformed both by double digits.
Industrials and capital goods are also well positioned. They benefit from grid modernisation, electrification, factory automation, energy security, renewables, nuclear power, defense and data-centre investment.
Defense is another structural growth area. Increasing NATO commitments, EU-level joint procurement and heightened geopolitical risk are encouraging governments to enter longer-term framework agreements, giving contractors better visibility and the confidence to invest in capacity.
Energy transition and AI infrastructure reinforce each other. Data centres require reliable electricity, while Europe must modernise grids, expand renewable capacity and improve energy security.
Investment implications
Even with these positives risks will remain. Inflation could prove sticky, rates could stay higher for longer, energy prices may become volatile, and geopolitics could weigh on sentiment. We still believe that overall, European equities now offer a stronger case than valuation alone suggests. Improving earnings, positive revisions, rising PMIs, stronger bank lending and multi-year capex themes are all helping broaden the opportunities. For investors, Europe may not replace U.S. equities, but it increasingly deserves a more prominent role in a diversified global portfolio that is less focused on AI and tech themes.