Morgan Stanley's Outlook on the European Stock Market for 2026
Last week I wrote about the S&P Global Q1 2026 forecast. We saw that Europe remained resilient during 2025, but that the start of 2026 looks a bit more uncertain. On one side, inflation stayed fairly stable, helped by a strong euro, expectations around German stimulus and slightly weaker labour data. On the other side, geopolitical tensions, U.S. tariffs and possible spillovers are still there, along with other factors that remain hard to predict.
A brief lookback at 2025
In the first half of the year, Europe’s growth surprised many investors:
Ahead of “Liberation Day”, tariff fears pushed investors to reduce U.S. exposure and diversify into Europe.
Talks and headlines around Russia–Ukraine negotiations led to several investment themes emerging in European equities.
In the second half, Europe continued to perform, but less strongly than the U.S.:
Around March, optimism peaked. Markets were very focused on Germany’s fiscal plans, but execution turned out to be slower than expected.
Earnings growth weakened significantly across Europe, with expectations downgrading through the year.
The 3 key points looking into 2026
Looking into 2026, Morgan Stanley’s Chief European Equity Strategist Marina Zavolock highlights three main points.
The direction of US really matters for European stock markets
The first one is that Morgan Stanley’s Chief Investment Officer Mike Wilson remains very bullish on U.S. equities. In that scenario, Europe would benefit from the “slipstream” created by a strong U.S. market. Simply put, if U.S. equities are up strongly, it becomes very hard for European markets to fall.
However, Morgan Stanley is much more cautious on European earnings. While consensus expects very strong earnings growth in 2026 (13%), their forecast is much lower (just below 4%). This means that any upside in Europe would likely come more from valuations improving, rather than from earnings growth.
Different investment themes - thematically driven market
Earnings growth expectations in Europe are very high. Consensus is pricing in strong growth, which creates the risk of disappointment.
High earnings growth consensus, and rising competition from China
Increasing competition from China and Europe’s old economy exposure (this meaning traditional and often slower-growth sectors such as energy, materials, utilities, banks and telecoms) could drive most disappointment thematically.
“Sectors like chemicals, like autos, those are some of the sectors towards the bottom of our model. Luxury as well,” highlights Zavolock.
Pace of execution of Germany’s fiscal plan
There are two sides to the German fiscal policy:
Germany has a €500 billion infrastructure fund, but economists expect more of that money to be redirected towards social spending. That is less supportive for corporate earnings, and execution has so far been slow.
Defence spending, however is a different story. Execution is improving, the need is large, and Morgan Stanley remains extremely very bullish on the sector, mentioning that “the need is immense”.
AI exposure and utilities
This is the real bull case in Europe. If returns on investment start to “become material enough that it is hard to ignore” (likely H2 2026), Europe could benefit more than many expect.
The utilities “pocket” carries a lot of strength, helped by raising power demand, linked to increasing AI adoption.
Sector preferences
Banks
Banks clearly stand out in Morgan Stanley’s view, aligning with the S&P Global outlook for Q1 2026. A theme in Europe outside of Germany is fiscal constraints, which highly benefits the banking sector as banks are positively exposed to the steepness of the yield curve.
Defense
As we previously saw, defense is one of Morgan Stanley’s preferred sectors for 2026, as they start to see execution start to pick up now.
Utilities
As Zavolock mentions, “utilities have broken out of their downtrend in terms of valuation versus their U.S. peers. But still trade at very wide discounts […] Now that there is endless demand for power on the back of powering AI, investors are willing to benefit the sector.”
A very comprehensive overview on the outlook for European equities for 2026. Looking forward to see how it all plays out.
Source: Morgan Stanley - Thoughts on the Market: The Outlook for European Stocks in 2026
