Europe has had its share of hardships this year: an energy shock created by the war in Iran, the hottest summer on record, competitive pressure from China, and political volatility. But beneath the turmoil, there's a bright spot not fully recognized by investors.
European companies are doing remarkably well.
In the second quarter, European companies, on average, reported earnings growth of 16% from the year-ago period, the strongest pace in three years and the biggest increase outside of the post-Covid recovery in more than a decade, according to BCA Research. Strategists expect the momentum to continue.
The Euro Stoxx 600 index is up 10.3% this year-just behind the S&P 500's 11.7% gain-yet strategists say U.S. investors still own little in Europe. That's reflected in valuations. The European market is trading at 16 times forward earnings compared with about 20 times for the S&P 500.
Henry McVey, head of global macro and asset allocation at private-equity giant KKR, sees a structural transformation that paves the way for more durable cash flows and a Europe better positioned for geopolitical and other shocks than it was when Russia invaded Ukraine in 2022.
Part of this shift is a normalization in interest-rate policy and an emergence from the negative interest-rate period that weighed on Europe for years. Germany approved a constitutional amendment early last year that changed the country's limits on federal debt, setting the stage for nearly one trillion euros in defense and infrastructure spending. Europe is also well positioned for a global increase in capital spending-for electrification and energy diversification, reshoring supply chains, and the buildout of artificial intelligence.
The return of a looser fiscal policy, along with a new credit cycle as banks benefit from higher interest rates, brings a breath of new life to a region that has been starved for public investment for more than a decade, says Davide Oneglia, director of European and global macro at TS Lombard.
Radical Change
"Something is actually changing radically," he says. Policymakers are pushing reforms to more deeply integrate the 27 countries in the European Union, including reshaping market infrastructure to improve liquidity and possibly spur cross-border mergers and acquisitions. These moves could help European industrial companies gain global scale and compete against U.S. and Chinese rivals.
Manufacturing activity has turned around following a three-year contraction that began in mid-2022, confirmed by recent Purchasing Managers' Index data. Oneglia sees the recovery broadening, helped by a much improved job market producing annual wage growth of 2.5% to 3%. Those are levels, he says, that would have been a dream in the 2010s. "Without the war, we would have seen a greater expansion of real incomes because inflation wouldn't have picked up that quickly and wages would have been OK. It's in a soft patch but the trend is upward," he says.
One potential catalyst would be an end to the Iran war. Oneglia says that even if a resolution of the conflict resulted in tolls in the Strait of Hormuz, that would still be a positive for Europe because it would restart the flow of energy and companies would adjust to slightly higher oil prices.
Risks remain. If the war continues into the winter, volatility could follow as central banks are forced to deal with inflationary pressures. A spate of elections this fall, including presidential elections in France and state elections in Germany, could inject bond market volatility. And Europe could find itself in a trade battle. Policymakers have set an October deadline to rebalance its trade relationship with China as its dependence on exports for growth and decreased appetite for European goods threaten the region's industrial heartland.
But strategists see any bumpiness as an opportunity in a market where investors are quick to price in bad news, and much slower to credit good news. Some of that good news is showing up in corporate earnings and in the economy, drawing investors looking to diversify their U.S. and AI-heavy portfolios.
A Bet on Banks
The improved outlook for European financials is a big positive for the market, where financials have three times the representation they do in the U.S. indexes. Most European banks make more than 50% of their earnings through net interest margins, so the normalization in interest rates is a major catalyst.
Financial companies in Europe stand to gain on other fronts, including an aging population and considerable retirement savings driving a need for financial advice. McVey also sees an opportunity for mergers and acquisitions as industrial companies in Germany, Italy, and France look to build scale to become more dominant globally.
The iShares MSCI Europe Financials exchange-traded fund offers a broad-based way to tap into the opportunity. Markus Hansen, co-manager of Vontobel's Quality Growth International Equity strategy, owns Norway's largest bank, DNB Bank. DNB was one of the rare banks that didn't need to raise capital during the 2008-09 global financial crisis and is well run, Hansen says.
The bank is a beneficiary of a strong local and export market for Norway, which is seeing strength in its shipping, drug, fishing, and technology industries. DNB looks attractive versus international peers, is focused on shareholder return, and is supported by the Norway government's one-third ownership, Hansen says. The stock trades at 1.6 times book value, with earnings expected to grow this year at 5% and a dividend yield of 5.5%.
Fund managers are also finding value in the luxury sector, which has seen stocks fall about 25% on average in recent years. The sector has had its share of bad news: Chinese consumers reluctant to spend amid a multiyear economic rut; tariffs; and, more recently, the war in the Middle East, a region that represents about 10% to 15% of sales for the sector.
Many companies have been able to pass along tariff costs, so the hit to Middle East spending hasn't been as bad as feared. The global rise in asset prices and a boom in initial public offerings in the U.S. and Asia also helps.
In the age of AI and abundance, Baillie Gifford manager Lawrence Burns favors iconic brands with a track record for craftsmanship, including Hermès International and Ferrari. "Things that are limited see their value go up-and these companies' value comes from things others can't replicate, like European heritage and links to the British royal family," Burns says.
Both are also staying fresh. The Birkin bag is a hit on TikTok, appealing to a younger audience. The recent launch of an electric Ferrari created debate around its design, but the first one was sold at a charity auction for $40 million-several times what was expected, in a nod to its brand power, Burns says. Another plus: Both Ferrari and Hermès were slower to move into China, which means more limited exposure as consumers there are still on the sidelines.
One of the knocks against Europe is that it doesn't have the AI superstars like Anthropic or OpenAI, nor the Metas or Googles of the world. That may be a positive if there is an AI-oriented market bust. That view also misses how well positioned Europe is for the global industrials boom as countries spend billions on electrification, energy diversification, reshoring, and building AI infrastructure.
Vontobel's Hansen owns Sandvik, a beneficiary of the copper mining needed to fuel many of these trends. The Swedish company provides the tooling and equipment for mining and gets a steady stream of business from maintenance and servicing parts. Another indirect beneficiary is Weir, a oil-and-gas company based in the United Kingdom that now focuses on water solutions required in mining.
Both are well positioned as demand for mining increases at the same time that regulatory and political hurdles make building new ones difficult. That puts a premium on their products that help make existing mines more effective. "If you are a large miner like BHP Group or Rio Tinto, once you have a contract, you tend to use the product even more because it's proven hardware and you're relying on it," Hansen says.
Weir trades at 21 times 2026 earnings and is expected to increase earnings per share 16%. Sandvik trades at 24 times with an expected earnings per share growth rate of 18. Both look cheap versus international peers, Hansen says. Both also pay a 1.5% dividend.
Playing Defense
Scott Rosenthal, a manager of the Hotchkis & Wiley International Value fund, says investors are underestimating the resilience and durability of earnings of some of the businesses in Europe that become even more attractive in a world where uncertainty is rising. Lately, Rosenthal is picking through more defensive sectors like healthcare and even consumer staples, which are contending with high commodity prices, tariffs, and changing preferences.
One such holding is Heineken. The beer giant's stock has lagged behind the market, up just 5% over the past year while the Dutch market is up 20%, in part due to concerns that people are drinking less alcohol. Rosenthal sees that as more of a trend in the U.S. and Europe, while much of Heineken's business comes from emerging markets. Rosenthal thinks Heineken still has growth prospects as emerging market consumers trade up to more premium beer as incomes rise and preferences evolve.
"The business is priced as if it is not going to grow," says Rosenthal. He expects Heineken to see increased sales as well as earnings improvement with the entrance of Rafael Oliveira as Heineken's chief executive in October. Oliveira formerly led coffee and tea maker JDE Peet's, focusing a portfolio of sprawling brands and allocating capital to improve growth and financial performance. Rosenthal expects him to use a similar playbook for Heineken.