Europe emerged as one of 2025’s big winners, with the Euro Stoxx index surging 31.3% to 22 December, and there is optimism that the region could top the charts again in 2026.
Despite the rise, valuations are not high, while German fiscal stimulus could boost sectors such as defence and infrastructure.
On the economic front, inflation and interest rates seem supportive, while any positive developments in the Russia-Ukraine war would also be positive.
But there are risks, with some experts expressing concerns that investors may be getting overly excited about the stimulus package and warning that political uncertainty remains a headwind as we move into next year.
Positive economic expectations
Following the European Central Bank’s (ECB’s) interest rate cutting cycle, the case for Europe has “strengthened considerably” heading into next year, according to Niamh Brodie-Machura, chief investment officer of equities at Fidelity International.
This is due to a combination of falling interest rates, fiscal support from governments and generally lower inflation, which have all created a “supportive backdrop” for further corporate investment and consumer confidence next year, she said.
Analysts at Goldman Sachs added that recent data on growth and inflation has tended to “surprise on the upside”, suggesting lower rates will be held steady next year. This is being supported by some “broadly resilient” household balance sheets.
Add in other tailwinds, such as a strong tourism sector, and the region currently seems “relatively balanced”, they said.
Fiscal stimulus to remain a theme
In Germany, the government has pledged a €500bn infrastructure fund and exemptions to its debt brake for defence spending. Chris Hiorns, head of European equities at EdenTree, said this will be “pivotal” to European growth next year.
Analysts at Goldman Sachs said that it is already driving a “capex revival” in sectors and areas that have fallen out of favour.
“Companies that have underinvested for two decades are making renewed investment in capital-intensive sectors – driven by energy transition and security, defence, reshoring, infrastructure upgrades, digitalisation, and AI [artificial intelligence].”
Defence was an area of particular interest, despite being one of the bigger winners in 2026. The MSCI Europe Aero and Defence index is up 66% year-to-date, according to data from FE Analytics, but it could have even further to run, the team at Goldman Sachs said.
“Even if the implementation of higher defence spending is gradual and complex, we believe it represents a potentially significant medium-term boost for growth.” They predicted it could boost German GDP by around 1.4% next year and 1.8% in 2027, “meaningfully narrowing” the gap between the US and the eurozone.
However, they said investors should remain vigilant, as early data suggests fiscal stimulus has been “relatively underwhelming” so far.
Valuations seem compelling
While Europe is more expensive than it used to be, the market still offers compelling value, according to Philip Wolstencroft, manager of the Artemis SmartGARP European Equity fund.
“European equities are slightly expensive relative to their history but, in the grand scheme of things, it's not a massive misvaluation,” he said.
This is because European equities underperformed for so long that they were already trading on “desperately cheap” multiples heading into 2025, with the rally bringing them to a more normal level.
Indeed, the market currently trades at a prospective price-to-earnings ratio (P/E) of about 15x, whereas other global markets trade at about 19x or higher, according to the Artemis manager. As a result, good stocks in the region that do “broadly sensible things” and deliver good growth at low multiples still have plenty of room left to run.
“I think there’s still a long way to go before we should get too cautious about the outlook for Europe,” Wolstencroft said.
Jupiter managers Niall Gallagher, Chris Legg and Chris Sellers agreed that valuations remained appealing “relative to other global markets” and are much less concentrated at the top of their market compared to other global peers.
This valuation gap is clear in the banking sector, according to the Jupiter team. Despite the MSCI Europe Banks rising by 83.4% so far this year, many companies still trade on “undemanding valuations”, with strong earning potential and continued efforts to return money to shareholders.
Political uncertainty
However, experts tempered their optimism by pointing to some of the risk factors heading into next year. France was an area of concern for Goldman Sachs as ongoing political uncertainty could put a “handbrake on any further investment”.
Indeed, French political uncertainty has been a continued risk in the region, with five different prime ministers in the past two years and the “National Assembly fractured” over the budget.
Coupled with the French presidential elections in early 2027, the picture for the region appears somewhat challenging.
Global political policy and consequences are also a concern for some investors. Jack Featherby, portfolio manager of JPMorgan European Discovery Trust, said: “While we see plenty of reasons to be positive, the most immediate risk is political uncertainty, particularly around US trade and tariff policy, which has created ripple effects across global markets.”
EdenTree’s Hiorns said that US policy has created a “long shadow” across global markets and the economy is “just beginning to feel the bite of US tariffs”. This could contribute to a softer global economy, leading to headwinds for European equities in the first half of next year, he said.