Top of the Morning: Eurozone equities - Positioning and outlook
The desk is optimistic about Eurozone equities as they anticipate an inflection point in economic conditions leading into 2026, spurred by falling energy costs and decreasing inflation. Per the full note source, UBS Analysts highlight improvements in cyclical indicators, including PMIs moving above the critical 50 threshold, which signals returning growth in the manufacturing sector. This aligns with our view of the Eurozone’s potential for recovery, already reflected in our consensus target of 1.075 for EUR/USD. As the European Central Bank has already reduced rates, watch for any shifts in manufacturing data that could underpin trading positions.
What the desk is arguing
The desk supports the view that Eurozone equities are set for an upward trajectory as several macroeconomic indicators point towards improvement. Recent reductions in energy costs, a cooling inflationary environment, and a supportive shift from the European Central Bank all signal a transformative period for the region's economic landscape. UBS highlights that these factors could lead to enhanced corporate performance, especially in manufacturing sectors, indicating confidence in stock valuations as you head into 2026.
Moreover, the recent improvement in Eurozone PMIs is noteworthy; breaking above the 50 level suggests expansion and recovery. This uptick in activity is critical for firms tied to the goods and manufacturing sectors, which have faced significant challenges over the past few years. The acknowledgment of a substantial German fiscal package also adds weight to the optimistic outlook, further encouraging investment in Eurozone equities.
Where it sits in our coverage
Our consensus target for EUR/USD is currently set at 1.075, with a range of expectations indicating a potential uplift. Noteworthy targets from other banks include: - jpmorgan targeting 1.10 for March 2026 - bofa with a more conservative stance at 1.04 for March 2026.
This optimistic outlook aligns with the positioning of jpmorgan, while bofa presents a contrasting view. The desk's assessment leans towards the upper end of the expected spread and reflects increased investor sentiment around Eurozone equities.
How other firms see it
Firms like jpmorgan and others are showing alignment with the desk's bullish stance on Eurozone equities, citing favorable structural reforms and economic indicators. In contrast, bofa takes a more cautious position, reflecting hesitancy about sustaining growth.
Keep an eye on related pairs such as EUR/USD, which could reflect these macro trends, alongside movements from the Bundesbank as they adjust their stance on economic conditions in the Eurozone. This data interplay will likely inform currency flows as sentiments evolve.
What the calendar says
No scheduled events on the calendar may influence immediate trading strategies, but as the macroeconomic landscape shifts in the coming months, keep an eye out for PMI releases that could provide further insights into the trajectory of Eurozone equities.
01Eurozone equities are at an inflection point ahead of 2026 with improving macroeconomic indicators.
02PMIs have recently cleared the 50 level, signaling potential recovery in the manufacturing sector.
03UBS's upgraded outlook is supported by decreased energy costs and a favorable shift in ECB policy.
04Investors should watch for shifts in manufacturing data that could validate Eurozone growth expectations.
Market implications
Monitor EUR/USD movements, particularly around the 1.075 level, as Eurozone economic data continues to emerge, particularly from manufacturing sectors.
Risks to this view
A reversal in growth expectations could arise if inflation unexpectedly resurges or if geopolitical tensions disrupt trade, undermining recovery in Eurozone equities.
ubs
Hi, everyone. Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel.
Today's conversation will focus on considerations when it comes to equity investing in the Eurozone, including a look at positioning recommendations and performance expectations of the UBS Chief Investment Office. Joining us for the conversation today, glad to welcome for his first appearance with us here on Top of the Morning, Matt Gilman, head of CIO Europe Equity Strategy. So with that, Matt, it's great to have you here on the podcast today.
Thank you for dropping by and for spending some time today with our listeners and our clients of UBS. Thanks for having me, Dan. Great to be here.
So Matt, to begin, I have to, of course, acknowledge the recent upgrade for Eurozone equities by the UBS Chief Investment Office. Can you talk to us a bit about the timing behind the upgrade, what's really changed and what should investors be watching out for? Yeah, great question.
Ultimately, I guess Europe's reached a bit of an inflection point, both on the cyclical side and the structural side. So we think as you go into 2026, Europe is something that should be on global investors' radars. On the cyclical side, Europe's been going through a pretty tough time the last few years.
But when you look at where we are today, energy costs have come back down. Inflation has cooled. The ECB's already cut rates by two percentage points.
We've got this big German fiscal package coming through. And then more recently, we're starting to get this greater clarity around trade. And that should mean that we should now finally get an upswing in activity, especially in goods and manufacturing.
And that's really what's critical to stocks. And that's really what's been the challenge that Europe's faced the last three years. And we're beginning to see the first green shoots of that coming through.
So the Euro area PMIs in the last few months have just broken through 50. That's the first time they've done that in over three years, so really since the start of the Russia-Ukraine war. And we think that can start to drive a material rebound in earnings.
So we're looking for earnings to grow about 25% over the next two years. And that follows three years of basically no earnings growth. And we would expect that earnings growth to probably show up more in 2027 rather than 2026.
But a lot of that acceleration will be happening next year. And I think markets will therefore increasingly focus on that as we go through next year, and they start to see that coming through in the numbers. Then on the structural side, it's not that Europe is necessarily well-placed, but I would say Europe is probably better placed than it's been probably for at least 15 years.
So I think post the financial crisis, the private sector went through a bit of an adjustment. The private sector debt has come down, so both households and corporates have pretty solid balance sheets. The banks are also much healthier.
They're a much better place to lend now. And that's really important because one thing that differentiates Europe to the U.S. is that we're much more reliant on bank lending as a source of financing. And then I think there's also demand for that lending as well.
So I think the outlook for CapEx is much better because a lot of that excess capacity post the financial crisis has been used up, but also got some very capital-intensive structural themes. So things like AI, power and resources, the European defense spending story, very capital-intensive. And of course, one company's CapEx is another company's top line growth.
And so for Europe's industrial heavy market, that's really important for getting growth going. And so talk about those structural trends as well. I think it's also important that we recognize that Europe is a little bit better placed for these structural trends than it was for the last 15 years.
The last 15 years was almost entirely about tech. And Europe, we don't have a particularly strong tech sector. But in things like power and resources, longevity, Europe is much better placed.
And we do find that there's more companies in this region with exposure to those trends. And then finally, I think there's been a bit of a wake-up call among the European leaders. I think they're starting to recognize that they can't rely on their export partners so much anymore.
They do need to try and restore their own competitiveness. Perhaps it's more hope than reality at this stage. But I think the German fiscal package was the first clear sign that Europe is starting to transition away from its old export-driven model.
We've also had the defense spending coming through. And we're increasingly hearing of more focus to try and foster innovation and support strategic investments. So I think all of that bodes well for the future.
But this combination, really, of this cyclical pickup and this structural improvement story, I think kind of sets Europe up quite well heading into 2026. So against that backdrop, Matt, let's talk a bit about positioning. From your vantage point, what opportunities look most compelling now as we head into 2026?
Yeah. So, Dan, I think it's basically what I just have talked about. It's kind of focusing on those cyclical opportunities and those structural opportunities.
So on the structural side, the key ways for us to play that here in Europe, it's things like IT, industrials, utilities. They give you exposure to the big global trends, the things like AI, the growth in power demand, electrification. Also, both IT and industrials give you a bit of a cyclical story.
They benefit from that capex spend coming through. And then in the case of industrials, they also give you exposure to reshoring of manufacturing capacity, but also the European defense story as well. On that structural side, we've also launched a new theme called European leaders.
So this is looking for the world-class businesses that we have here sitting in Europe. And of course, when you're investing in Europe, you're not buying the European economy, you're buying European businesses. These are global businesses that just happen to be listed in Europe.
And in many cases, they're global market leaders in what they do. So we think there's some opportunities in these names, which are reasonably priced still, and they still have exposure to these positive global developments, but also they give you exposure to some of these positives that are happening here in Europe as well. And then on the more cyclical side, I think this is really where it's time to add more of the new positions.
This is what's really starting to change. So we've upgraded the banks in November to attractive. We think they're still reasonably priced, but from here, the earnings should start to re-accelerate.
They should benefit from that loan growth pickup. You've got fees that should pick up with capital market activity starting to come back. And there's still this ongoing asset repricing from the ultra low rate period of the last few years.
And then we've also upgraded German equities. Now, this market had a lot of enthusiasm at the beginning of the year. That enthusiasm has very much faded.
But this is a market, it is more cyclical, so it benefits from that global cyclical pickup that we're looking for. But it also has this unique fiscal story. So Germany is spending more than 20% of GDP on infrastructure and defence, and that's coming over the next 12 years.
And that should support growth. So that will support, I think, in particular, the smaller businesses that are perhaps a little bit more domestic, the MDAX index. And that's been a really big laggard in recent years.
In fact, it's still below pre-COVID levels. But it also, I think, supports the large cap DAX index. That gives you some of that exposure, but also it's going to give you exposure to some of the biggest stocks in Germany, which gives you exposure to a lot of those big structural themes, things like AI, pan resources, European defence spending.
You also get that with the big caps as well. Okay, so quite a few considerations there when it comes to positioning. Let's talk numbers a bit, Matt.
How do eurozone equities stack up? Are stocks actually cheap? Or is there more to the story?
What sort of returns are realistic from your vantage point? Well, I guess the good news is, look, we're not talking about bubble valuations here in Europe. But it's not that Europe's necessarily cheap.
So we trade just above 14 and a half times forward PE. That's a small premium to history. But I think really where Europe stands out is the discount to global equities.
So we're at 22% discount, PE discount to global equities. And even if you adjust the sector differences, or you remove a lot of these AI stocks, which we don't have here in Europe, you still look at Europe and it looks cheap relative to comparable peers. But I think when you're looking at these valuations, it's also important to bear in mind the E, the earnings.
We think we're near the bottom of the earnings cycle, we think you're about to see this acceleration come through. So if that acceleration that E comes through, those PE multiples, which like I said, they're not cheap. But I think you very quickly grow into those multiples.
So for us, the returns from here really come from earnings rather than valuations. And we're looking for the euro stocks 50 at 6,200 by the end of next year. As we're recording, that's about a 9% return from here.
And on top of that, you get about a 3% dividend yield. Now, Matt, of course, with all types of investing comes risk in terms of risk considerations, or even headwinds, anything you would highlight that participants should be mindful of? Yeah, of course.
Nobody said no investments without risk. And it's same for European equities. I mean, given the reliance on the global growth story to drive that earnings recovery that we're looking for, I think global growth has to be one of the key risks.
You know, what if it disappoints? What if we see weaker demand? Or what if those trade shocks start to come back?
That's something we need to be mindful of. It wouldn't be Europe if we didn't talk about politics. Political uncertainty could certainly raise its head again.
The recent months we've had a lot of focus on France. They've got a presidential election coming up in 2027. But of course, given the importance of Germany and the fiscal story there, any political uncertainty there could also be a cause for some pullback in sentiment in the region.
I think also one of the risks, and this is something which really impacted markets this year here in the region, is the stronger Euro. Now, this year, it came with weaker growth, and that's why it was particularly bad. But I do think if we'd like to see a stronger Euro again in 2026, I would at least hope it's coming with better growth.
That's normally the situation where we get the stronger Euro. That's much less of a problem because we have that growth backdrop to support us. But I do think the currency is important because these businesses we have here in Europe, they're very globally exposed.
More than half their revenues come from outside of the European region. And then also on the risk side, the negative side, structural headwinds. The last few years have had these high energy costs.
There's been rising competition from China. I think neither of these issues are going away anytime soon. But we do at least in the short term, we have this energy relief package in Germany, and that can help lower energy costs until 2028.
And I think the policy change we've seen out of China, this focus on anti-involution is also potentially helpful at the margin, potentially reduces some of the deflationary fears that have been in place for the last couple of years. But there's also a positive risk I think you need to be aware of. And that's what if we did finally see Russia-Ukraine peace?
And there's really four mechanisms at which this impacts Europe. It's through, one, lower energy costs. Secondly, improving sentiment.
We've really seen a collapse in business, consumer, investor sentiment since that war broke out. But then to a lesser degree, it can also drive benefits from fewer sanctions. And also the hope of potential reconstruction as well can also help be a source of demand.
So I'd say a mixed bag around the risk, something we definitely need to be mindful of. But I think given the risk-reward on the market, we think it looks quite attractive here. Yes, some helpful transparency there, Matt, when it comes to risk considerations to be mindful of.
As we begin to close out for today, and thank you, Matt, for covering all of the ground that you did for our listeners and our clients. Anything you would like to reinforce or any final thoughts, takeaways you would like to leave our listeners with today? I think one of our key messages as we go into 2026 is this idea that we're going to see a broadening out of markets, a broadening out within AI, but also broadening out beyond AI.
I think that's where Europe starts to look much more interesting, because Europe does benefit from that broadening macro backdrop. So I do think Europe needs to be on investors' radar. We have that cyclical recovery that we think is going to come through.
We have that structural story that the margin is starting to get a bit better. And we have valuations. We're not talking about bubble valuations here.
So I think valuations remain quite reasonable. So for us, I think this is a market that if you are looking to diversify, if you are looking to protect against potential volatility in 2026, adding Europe to portfolios could be something that I think should be on investors' minds. Well, Matt, very generous with your time today and for sharing your insights into investment considerations when it comes to Eurozone equities.
Great to have you here on top of the morning and looking forward to continuing our conversation as we look ahead into 2026. Thank you again, Matt, for your time today. Great speaking with you.
Great. Thanks, Dan. And again, today we have been joined by Matt Gilman, head of CIO Europe Equity Strategy.
Also would like to promote the 2026 Year Ahead Report from the UBS Chief Investment Office. Title is Escape Velocity, which is now available for you up on UBS.com forward slash year ahead. For clients of UBS, simply reach out to your UBS financial advisor if you would like to receive a copy of CIO's 2026 Year Ahead publication directly.
From UBS Studios, I'm Dan Cassidy. Thank you for joining us. Visit UBS.com slash CIO to view the latest research. brokerage services are separate and distinct, differ in material ways, and are governed by different laws and separate arrangements.
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