European Equities: Multiple Expansion Over Earnings Growth Amidst Structural Headwinds

Key Quotes

"As we look ahead to 2026, there's a lot going on in Europe stock markets. From shifting economic wins to new policies coming out of Brussels and Washington, the investment landscape is evolving quite rapidly. Interest rates, profit forecasts, and global market connections are all in play."

Paul Walsh introduces the discussion by highlighting the dynamic and rapidly evolving nature of the European stock market landscape for 2026. He points out that various factors, including economic shifts, policy changes, interest rates, and profit expectations, are all contributing to this complex environment.

"But the year 2025, I would say is a year of two halves. So, we began the year with a lot of, kind of, under performance at the end of 2024 after U.S. elections, for Europe and a decline in the euro. The start of 2025 saw really strong performance for Europe, which surprised a lot of investors. And we had kind of catalyst after catalyst, for that upside, which was Germany’s ‘whatever it takes’ fiscal moment happened early this year, in the first quarter."

Marina Zavolock summarizes 2025 as a bifurcated year for European stocks, noting an initial underperformance followed by a surprisingly strong first half driven by catalysts like Germany's fiscal policy and positive developments regarding the Russia-Ukraine conflict. She indicates that this strong start was not universally anticipated by investors.

"But our upside is more driven by multiple expansion than it is by earnings growth. Because what we continue to see in Europe and what we anticipate for next year is that consensus is too high for next year. Consensus is anticipating almost 13 percent earnings growth. We're anticipating just below 4 percent earnings growth. So, we do expect downgrades."

Marina Zavolock explains that while European equities may see upside in 2026, this is expected to be primarily due to multiple expansion rather than robust earnings growth. She contrasts the consensus forecast of nearly 13 percent earnings growth with her team's expectation of just under 4 percent, anticipating that downgrades are likely.

"And thematically, why do we see these downgrades? And I think it's something that investors probably don't focus on enough. It's structurally rising China competition and also Europe's old economy exposure, especially in regards to the China exposure where demand isn't really picking up."

Marina Zavolock identifies structurally increasing competition from China and the exposure of Europe's traditional industries to this dynamic as key thematic reasons for expected earnings downgrades. She emphasizes that this factor, which has driven significant downgrades in previous years, is often underestimated by investors.

"And this is the real bull case for me in Europe. If AI adoption, ROI starts to become material enough that it's hard to ignore, which could start, in my opinion, from the second half of next year. Then Europe could be seen as much more of a play on AI adoption because the majority of our index is exposed to adoption."

Marina Zavolock presents AI adoption as a significant potential bull case for European equities, suggesting that if the return on investment becomes substantial enough, Europe's broad exposure to AI adoption could drive market performance. She believes this trend could become more pronounced from the latter half of the following year.

"And if you look -- whether it's at our sector model or you look at our top 50 preferred stocks in Europe, the list is full of Banks. And I didn't mention this in the thematic portion, but one of the themes in Europe outside of Germany is fiscal constraints. And actually, Banks are positively exposed to that because they're exposed to the steepness -- positively to the steepness -- of the yield curve."

Marina Zavolock highlights that banks are prominently featured in their sector model and top stock picks for Europe, attributing this preference to their positive exposure to fiscal constraints and the steepness of the yield curve. She notes that this sector consistently delivers strong earnings upgrades and remains attractively valued.