European Equities Experience Significant Gains in First Half of 2026

Despite these gains, the overall return may not fully represent the strength of Europe’s domestic corporate sector. The MSCI Europe Small Cap Index returned only 5.41 percent in the first half, reflecting a subpar performance compared to larger firms. It’s also noteworthy that about half of the revenues for the companies in the STOXX Europe 600 are generated outside Europe. The European Commission projected in May that the European Union's gross domestic product (GDP) will grow by a modest 1.1 percent in 2026, indicating that the rally is more closely tied to the earnings composition of listed companies rather than a robust regional economy.

Throughout the year, the market landscape evolved significantly. By late February, major European indices had risen by 6 to 8 percent, fueled primarily by sectors like basic resources, telecommunications, oil and gas, and utilities. However, geopolitical tensions in the Persian Gulf impacted energy prices, reducing support for travel and consumer sectors. In Q2, technology stocks surged, reaching their highest quarterly increase since 2001, as global enthusiasm for AI expanded beyond the United States and Asia. Concurrently, a 38-percent drop in oil prices buoyed travel and leisure stocks, which rose by over 19 percent.

Corporate profits played a critical role in underpinning market resilience. According to LSEG’s I/B/E/S data released on July 23, STOXX Europe 600 companies were expected to see a 17.3 percent year-on-year earnings growth in Q2. Notably, the energy sector was projected to experience a remarkable 122.6-percent increase, with overall earnings surging by 7.2 percent when excluding energy. Revenue growth was anticipated at 11.5 percent, marking the highest rate since late 2022 after a prolonged period of stagnant or declining results.

The influence of AI on Europe’s growth trajectory has been significant. Morgan Stanley estimated that AI-related capital expenditures accounted for roughly 70 percent of the MSCI Europe Index's performance in 2026. Companies involved span a range of industries, including semiconductors, electrical networks, and data-centre components. ASML, a major player in advanced chip manufacturing, was the largest constituent of the index, boasting a 5.43 percent weight as of June 30. Its stock rose 60 percent by July 20, pushing its market value close to $700 billion and enhancing its influence on Europe’s market gains.

Various industrial sectors further boosted this exposure, with firms like Infineon Technologies and Siemens Energy benefiting from strong demand in power semiconductors and distribution equipment. Siemens Energy, for example, reported €17.75 billion in orders during the first quarter, up 29.5 percent from the previous year, and showed a record backlog of €154 billion.

Financial services have also emerged as a key growth area in Europe, especially in countries like Britain, Spain, and Italy, where higher lending margins and increased trading revenues have led to improved profitability. Santander reported a 10 percent year-on-year increase in second-quarter net interest income, reaching €11.69 billion, with shares gaining 18 percent year-to-date by late July.

Public spending has reinforced the stock market as well, particularly through investments in defense and infrastructure. EU member states are projected to invest €454 billion in defense for 2026, marking an 8.6 percent increase from 2025 and a 75.3 percent rise since 2021. Thales Group recorded €12.47 billion in orders for the first half of the year, a 21 percent annual increase.

Energy prices have continually influenced which sectors and national markets led the way. Initially, high commodity prices favored oil producers, benefiting the resource-heavy FTSE 100 Index. However, the significant Q2 decline in oil prices alleviated some pressure on transport and production costs, which in turn supported household purchasing power. András Vig, an investment strategist at Invesco, stated that lower oil prices enhance Europe’s investment proposition against energy-exporting countries like the US.

Valuations of European indices also presented a case for investment. On June 30, the MSCI Europe Index traded at 15 times forecast earnings with a dividend yield of 2.80 percent, compared to 19.17 times and 1.52 percent for the broader MSCI World Index. While European equities are not as inexpensive as before, they still offer relative value, as explained by Michael Field, Morningstar’s chief European equity strategist.

The less concentrated structure of European indices has also been a factor. By the end of June, the 10 largest constituents of the MSCI Europe Index comprised only 21.68 percent of the index, with no company exceeding ASML’s 5.43 percent weight. This structure allows more companies to contribute to returns, even though their earnings are intricately linked to broader economic trends and external factors.

However, ongoing doubts about the investment attractiveness of European equities remain. Following a net loss of funds for ten consecutive weeks, European equity exchange-traded funds (ETFs) recorded approximately $1.5 billion in inflows during the week ending June 19, highlighting persistent investor skepticism. Challenges facing the market include underperformance in smaller companies, the luxury sector, and software industries amid weak demand from China, and concerns about whether semiconductor companies can maintain their revenue growth in light of high expenditures on AI technologies and infrastructure.

In summary, while European equities have benefited this year from strong performance among their largest companies and relatively attractive valuations, sustaining this momentum will depend on addressing key challenges such as converting government spending into tangible orders and maintaining strong earnings in the face of market uncertainties.