Europe Outlook 2026: Access growth at a reasonable price

• Europe’s economic recovery is becoming more balanced as it shifts away from relying on just a single growth engine.

• Europe’s earnings outlook is anchored by financials and healthcare as core pillars. Cyclical sectors could also rebound, with defence-led spending supporting a recovery across industrials.

• Europe is positioned as the primary liquid alternative to the US assets. As hedge fund positioning data and ETF flow suggest, global investors increasingly rotate into Europe when sentiment toward the US deteriorates.

• Europe offers access to growth at a reasonable price, supporting a constructive upgrade in market attractiveness. With earnings growth expected to rebound toward an estimated 10% in 2026 and valuations still at a meaningful discount to the US. With fair PE ratio of 15, we forecast upside potential of 14.5% by year end of 2027.

As the US economy shows early signs of strain and equity valuations appear stretched relative to growth, global capital is increasingly rotating toward alternative markets. Europe has emerged as a key destination for these flows. This article evaluates Europe’s investment appeal for 2026 from a macroeconomic, sectoral, and valuation perspective.

Related article: US Outlook 2026: Downgrading US equities on softening economic fundamentals

Europe’s growth is now more balanced

Eurozone growth has entered a phase of gradual acceleration, with 3Q GDP expanding 0.3% quarter-on-quarter, exceeding both preliminary estimates and the previous quarter (Chart 1). While growth momentum differs across countries, the recovery is becoming more broad-based, reflecting contributions from both peripheral and core economies.

In the near term, peripheral economies such as Spain, Portugal and Greece – once considered the problem children of the European Union (EU) – are providing important growth support. These countries benefit from substantial EU fiscal transfers under the Next Generation EU programme, more favourable demand structures driven by tourism and services, and improving labour market conditions that underpin domestic consumption. At the same time, sustained fiscal consolidation has materially strengthened sovereign balance sheets, reduced funding costs and improved policy credibility, creating a more durable foundation for growth.

Chart 1: Eurozone GDP is accelerating in 3Q, Spain leads

Meanwhile, core economies, particularly Germany, are transitioning from a period of cyclical weakness toward a policy-supported recovery. Although manufacturing softness and implementation lags have weighed on growth, fiscal policy has turned decisively more supportive, with large-scale infrastructure and defence spending and a loosening of fiscal constraints. As these measures gain traction and the global manufacturing cycle turns in 2026–27, growth in core economies is expected to gradually improve and spill over across the region.

Overall, Europe’s economic recovery is no longer reliant on a single growth engine. The resilience of peripheral economies, combined with policy-driven improvements in core markets, is creating a more balanced and durable growth structure over the medium term.

Financials: A structurally repaired earnings engine

Since the Global Financial Crisis and the European sovereign debt crisis, Europe has established a much stricter banking regulatory framework. After more than a decade of deleveraging, capital strengthening and regulatory tightening, asset quality issues have been largely resolved, non-performing loan ratios have fallen to around 1.9%, down to less than one-third of their level a decade ago.

At the same time, unlike the prolonged ultra-low or zero-rate environment that followed the crisis, the ECB policy rate has returned to a neutral range, providing a more supportive and sustainable earnings backdrop for banks. This shift has facilitated a structural recovery in profitability, reflected in forward ROE expectations, which have converged with, and even slightly exceeded, those of US peers since mid-2023, laying a fundamental foundation for valuation re-rating (Chart 2).

Chart 2: Europe banks forward ROE is catching up with US banks

Over the past four quarters, European banks have consistently delivered revenues and net profits above market expectations, while provisioning has remained well below prior assumptions, underscoring stronger-than-expected asset quality and earnings resilience. Cost pressures have shown some volatility but remain broadly in line with expectations.

From an income perspective, European banks’ earnings base has become more robust. Net interest income remains the core pillar, while loan growth, although still moderate, has shown gradual improvement. Looking ahead, infrastructure and defence spending in Germany, together with EU-level rearmament initiatives, should help lift corporate investment sentiment and provide additional medium-term support for credit demand.

At the same time, fee income has begun to recover alongside improving capital market activity. Several banks, including UBS and Barclays, reported better-than-expected investment banking revenues. European M&A volumes rose 36% year-on-year in the third quarter and were up 11% year-to-date. Banks with meaningful US exposure also benefited from a stronger US deal cycle, where M&A volumes increased 63% year-on-year in the third quarter and 38% year-to-date. ING highlighted solid momentum in fee income, while Deutsche Bank benefited from strength in fixed income trading.

Capital discipline underpins sustainable shareholder returns

After more than a decade of deleveraging and tighter regulation, eurozone banks now operate with substantial capital buffers. CET1 ratios are at their highest levels in nearly a decade and remain well above regulatory requirements.

Management teams continue to prioritise returning capital to shareholders through dividends and share buybacks. Capital allocation remains highly disciplined: shareholder distributions take precedence over aggressive expansion; M&A activity is approached selectively, with high return thresholds and a focus on strategic fit; and capital return commitments are clearly articulated. For example, BBVA plans to return EUR 36 billion, around 30% of its market capitalisation to shareholders between 2025 and 2028.

As a result, we expect European banks to continue delivering stable and sustainable shareholder returns, with median payout ratios over 48%, dividend yields of 4–5%, and ongoing share buybacks.

Table 1: Top 10 banks continue to commit to high shareholder returns

Name	Div Yield FY2025(%)	Div Yield FY2026(%)	Div Yield FY2027(%)	Payout Ratio FY2025(%)	Payout Ratio FY2026(%)	Payout Ratio FY2027(%)
Banco Santander SA	2.55	2.91	3.47	24.61	24.68	24.55
Barclays PLC	2.10	2.38	3.03	20.88	18.21	17.75
BNP Paribas SA	7.36	7.98	8.86	51.08	51.54	51.30
Banco Bilbao Vizcaya Argentari	4.39	5.03	5.47	48.30	48.85	48.55
HSBC Holdings PLC	4.84	5.13	5.56	54.38	51.14	50.61
ING Groep NV	4.82	5.18	5.92	57.53	50.59	50.40
Intesa Sanpaolo SpA	6.31	6.90	7.37	72.65	73.27	71.07
Lloyds Banking Group PLC	3.78	4.41	5.15	52.24	44.78	44.10
NatWest Group PLC	5.11	5.56	6.25	49.47	49.79	50.19
UniCredit SpA	4.81	5.43	5.96	46.45	48.85	49.05
UBS Group AG	2.51	2.75	2.97	43.48	34.41	29.86
Deutsche Bank AG	3.00	3.54	3.90	33.79	35.47	35.75
Average	4.30	4.77	5.33	46.24	44.30	43.60
Median	4.60	5.08	5.51	48.88	48.85	48.80

Healthcare: The core pillar for Europe’s investment case

The healthcare sector has historically provided resilient returns during periods of market volatility, yet it has underperformed other sectors in Europe this year. This underperformance has largely been driven by sentiment rather than fundamentals, as policy uncertainty in the US weighed on investor confidence. Concerns centred on potential tariff measures proposed by former President Trump and the possibility of “most-favoured-nation” (MFN) pricing requirements for large pharmaceutical companies, raising fears over future profitability and triggering a bout of sentiment-driven selling.

In practice, policy uncertainty is increasingly being resolved through negotiation rather than confrontation. Since the sector’s lows earlier this year, European healthcare stocks have rebounded as policy risks have begun to crystallise into more tangible and manageable outcomes. Several large pharmaceutical companies have reached agreements with the US government, securing MFN-related concessions in exchange for tariff exemptions. European leaders such as AstraZeneca and Novo Nordisk have obtained exemptions for up to three years while committing to partial relocation of production capacity to the US.

AstraZeneca has stated that the impact is manageable and does not affect its 2026–2030 mid-term targets, while Novo Nordisk expects only a low single-digit impact on 2026 global sales growth, with longer-term volumes supported by broader insurance coverage. Collectively, these cases send a clear signal that policy risk is not an unquantifiable threat, but a negotiable and priceable cost item, significantly improving earnings visibility and investor confidence.

As policy concerns ease, investor focus is shifting back to fundamentals. Despite recent rally, valuations in European healthcare remain at historically low levels, while underlying business quality and medium-term earnings visibility remain intact. Healthcare is highly concentrated in a small number of global pharmaceutical leaders. The three largest constituents, AstraZeneca, Roche and Novartis, together representing around 42% of the sector, have collectively generated tens of billions of euros in free cash flow over recent years. Between 2020 and 2024, Roche and Novartis maintained annual free cash flow in the EUR 10–16 billion range, while AstraZeneca’s free cash flow rose steadily from around EUR 3 billion to approximately EUR 9.5 billion, highlighting the sector’s strong and durable internal cash generation.

This strong cash flow base is particularly valuable in an industry characterised by high R&D failure rates and significant capital intensity. It enables large pharmaceutical companies to absorb development setbacks, sustain high levels of in-house R&D investment and selectively pursue external acquisitions to replenish pipelines. Over the past five years, R&D spending has consistently accounted for around 18–25% of revenues among leading European pharma companies. Against the backdrop of easing financial conditions and approaching patent cliffs, industry consolidation has accelerated, with global healthcare M&A activity rising by 20%, 43% and 52% year-on-year across successive quarters in 2025. Pipeline depth remains broad, spanning hundreds of assets across multiple therapeutic areas and clinical stages, underscoring a diversified and balanced innovation engine (Chart 3).

Chart 3: Global healthcare deal volume has picked up significantly this year

Recent sales performance provides further confirmation of earnings momentum. In oncology, the largest therapeutic market, several blockbuster drugs delivered upside surprises in the first three quarters of 2025. Novartis’ Kisqali generated USD 3.46 billion in sales over the period, growing more than 62% year-on-year, with full-year sales expected to exceed USD 4.9 billion, making it one of the fastest-growing large oncology drugs this year. AstraZeneca and Daiichi Sankyo’s Enhertu recorded sales growth of over 30%, while Roche’s Phesgo achieved growth exceeding 50%. These high-growth flagship products reinforce confidence in the sector’s earnings durability and medium-term growth prospects.

As a result, the fundamental quality and earnings visibility of the European healthcare sector remain intact, while valuations continue to trade below historical averages. This disconnect between stable fundamentals and un-recovered valuations offers a relatively attractive risk-reward profile for long-term investors.

Cyclical upside from defence-led spending

As defence and security rise to the top of Europe’s policy agenda, fiscal frameworks are undergoing a structural shift with implications extending beyond the defence sector. At the EU level, the European Commission approved provisional allocations under the EUR 150 billion “Security Action for Europe” (SAFE) programme in September, with first disbursements expected as early as 1Q next year to support joint procurement of European-manufactured military equipment.

At the national level, Germany’s EUR 100 billion special defence fund is entering its peak execution phase over 2025–27. In parallel, the institutional relaxation of the debt brake in March removed borrowing constraints on defence spending above 1% of GDP, creating additional fiscal space to support defence expenditure toward the 3.5% of GDP target. Together, these measures mark a shift from one-off defence outlays toward a more durable and sustainable spending framework.

This transition materially improves long-term visibility for defence contractors and supports broader industrial activity. Higher fiscal headroom underpins multi-year procurement plans, enabling investment in equipment, capacity expansion and supply chains. Given the manufacturing-intensive nature of defence production, demand spillovers extend along the industrial value chain. With industrials’ earnings growth expected to remain subdued in 2025, defence-led demand could catalyse a cyclical recovery from a low base.

Increasing strategic relevance for global diversification

Hedge fund positioning data and ETF flow trends suggest that global investors increasingly rotate into Europe when sentiment toward the US deteriorates. Europe functions as the primary liquid alternative market for global diversification, particularly during periods of US-specific macro or policy uncertainty. This growing role as a strategic diversification hub enhances Europe's structural investment relevance, hence Europe’s risk premium should compress (Chart 4).

Chart 4: ETF flows suggest Europe to be a primary alternative allocation destination should US market deteriorate

Euro’s status as the second-largest reserve currency positions Europe as a natural beneficiary of gradual de-dollarisation trends, reinforcing structural demand for euro assets.  Reflecting this improving structural demand profile, we have upgraded Europe’s fair PE from 14 to 15, consistent with its 5-year and 10-year historical average and renewed role in global portfolios.

Access growth at a reasonable price

Relative to the US, Europe offers a more attractive balance between growth and valuations. While US consensus expects earnings growth of around 12-13% alongside a forward PE ratio exceeding 26, Europe is positioned to deliver approximately 10-12% earnings growth at a materially lower valuation of around 16 times forward earnings.

Despite recent performance, the valuation discount remains pronounced: the STOXX 600 continues to trade at roughly a 35% discount to the S&P 500, well above its long-term average discount of around 22%.

Looking ahead, with earnings resilience in defensive sectors and early signs of recovery emerging among cyclicals supported by a low base effect, broader earnings rebound across the market appears likely. Combined with Europe’s rising strategic relevance in global allocations, we therefore upgrade our star rating on Europe from 2.5 stars  “Neutral” to 3.0 stars “Attractive”. With a fair PE of 15 and a projected earnings growth toward 10% in 2026 and 12% in 2027, we forecast upside potential of 14.5% by year end of 2027. 

Investors can access this opportunity by investing in the Eastspring Investments Unit Trusts - Pan European SGD, our recommended equity fund for Europe. For a low-cost, index-tracking approach, our recommendation would be the Vanguard FTSE Europe ETF.

Table 2: Projections for Stoxx 600 index

Stoxx 600 index	2024	2025E	2026E	2027E
EPS	35.65	35.66	39.25	44.00
EPS growth	-2.6%	0.0%	10.1%	12.1%
PE Ratio	16.2	16.2	14.7	13.1
Upside Potential	-	-	-	14.5%
Target Price (EUR)	-	-	-	660
Source: Bloomberg Finance L.P., iFAST Estimates
Data as of 30 November 2025

Chart 5: Price projection for Stoxx 600 index