• Europe remains vulnerable to external energy shocks, with higher energy prices feeding into inflation, delaying policy easing, and pressuring margins in energy-intensive sectors.

• The same conflict is also accelerating a structural spending cycle in defence and energy infrastructure, improving the medium-term outlook for selected sectors.

• Defence, regulated utilities, and electrical equipment are areas of relative support, while banks and healthcare remain relatively resilient on earnings.

• We downgrade Europe from Attractive to Neutral, as selected sectors remain constructive, though they are not enough on their own to offset the tougher macro backdrop.

The energy shock is real, but the same conflict is also driving Europe’s largest defence and energy security spending cycle in decades. The investment case is not broad avoidance — it is selectivity.

The consensus narrative is right, but incomplete

European equities have increasingly been framed as a casualty of the prolonged Middle East conflict. Higher energy prices, rising inflation risks, and a less supportive policy outlook have all contributed to a weaker near-term recovery profile.

This view is not wrong. The transmission channels from energy to inflation, rates, and earnings are real and already visible in macro data.

But it is incomplete. The same forces creating these headwinds are also triggering a structural shift in fiscal spending and industrial policy. This introduces a second, less recognised dynamic — one that supports selected sectors even as the broader macro backdrop deteriorates.

The headwinds are real and should not be dismissed

The macro backdrop has clearly become more challenging. Europe remains structurally exposed to external energy shocks. While the region has diversified its energy sources since 2022, net energy imports still account for around 57% of total consumption, and fossil fuels continue to make up a significant share of the energy mix. This leaves Europe more vulnerable than economies with stronger domestic energy bases when oil and gas prices rise.

Chart 1: Europe has been diversifying its energy source, but import dependence remains high.

Even if the conflict were to end now, the energy shock would not necessarily reverse quickly. Damage to critical LNG infrastructure could take years, rather than months, to repair. For example, if around 17% of capacity at Qatar’s Ras Laffan LNG complex has been impaired, that would be equivalent to roughly 3% of global LNG supply, and restoring that capacity could take three to five years.

Unlike oil, LNG cannot simply be redirected through alternative pipelines, which means reopening shipping routes alone would not fully reverse the supply disruption. In other words, the macro risk lies not only in the duration of the conflict, but also in the persistence of the damage it leaves behind.

Two key transmission channels are now at work:

1.      Inflation and policy risk

Higher oil and gas prices raise inflation risk and reduce the room for central banks to ease policy — weakening one of the earlier supports behind Europe's recovery. If inflation remains firmer for longer, the European Central Bank (ECB) and the Bank of England (BOE) are likely to stay more cautious than previously expected. Germany illustrates the stakes: its reliance on imported energy and industrial-heavy structure make it one of the more exposed major economies, and growth expectations have already been revised down.

Chart 2: European consumer price surged in March.

Chart 3: Market has priced in multiple hikes for ECB and BOE.

2.      Earnings pressure through input costs

Higher oil and gas prices can raise fuel, electricity and other input costs, particularly for energy-intensive businesses. That can pressure operating margins and, if sustained, weaken competitiveness. This matters for investors because the European equity market still has meaningful exposure to energy-intensive sectors such as industrials, basic resources, chemicals, and construction materials. In other words, the effect is not confined to a small number of companies.

Taken together, these factors do not invalidate Europe’s structural story, but they do make the near-term environment more difficult.

The same conflict is accelerating Europe’s largest spending cycle in decades

What the market is missing is the other side of the ledger. The same geopolitical tensions driving energy costs higher are also triggering a much larger defence and energy security spending cycle across Europe.

In defence, the current conflict does not mark the start of Europe's rearmament cycle, but it accelerates what was already underway. The deeper driver is structural: Trump has repeatedly threatened to withdraw the US from NATO. Whether or not those threats are carried through, they have already changed European strategic thinking in a way that is difficult to reverse. European governments are no longer spending on defence because Washington asked them to meet the 2% GDP target. They are spending because they have concluded they cannot rely on Washington to meet it for them.

The most direct beneficiary is defence. European defence companies have already delivered strong performance, supported by improving order books and rising backlog visibility. These are not typical cyclical recoveries, but structural re-ratings underpinned by stronger government commitments and greater long-term procurement visibility.

Energy infrastructure is another area of selective support. The European Commission estimates that EUR 584 billion of electricity-grid investment will be needed by 2030, reflecting ageing networks, rising electrification, and the need for greater cross-border capacity. This is already feeding through to listed utilities, with Bloomberg Intelligence indicating that a larger share of sector investment is shifting toward networks. For regulated utilities, that matters because grid capex expands the regulated asset base, supporting more visible earnings over time.

Electrical-equipment companies such as Schneider Electric and ABB sit one layer upstream and benefit from the same grid investment cycle — but their investment case extends beyond Europe. Both companies are significant suppliers to the US market, where AI-driven data-centre expansion is generating substantial demand for power management and electricity infrastructure. This makes the electrification theme a global one, with European policy acting as one of several demand drivers rather than the sole catalyst.

The implication is that Europe is simultaneously facing a macro headwind and a structural investment tailwind — and that tailwind, through the electrical equipment and grid modernisation theme, connects to a global electrification cycle that extends well beyond European borders.

Selectivity matters more in the current market

The tougher macro mix does not mean Europe should be abandoned, but it does argue for a more selective approach.

The first group consists of sectors with direct structural support from the spending cycle. Defence remains the clearest example, while regulated utilities and electrical equipment companies are increasingly central to the grid and electrification build-out. These parts of the market are tied more closely to policy-led investment and infrastructure needs than to the near-term economic cycle.

Investors who wish to gain exposure to the European defence sector may consider the Wisdomtree Europe Defence UCITS ETF - EUR ACC (LSE:WDEF). For broader exposure to the global smart grid and electrification infrastructure theme — including companies benefiting from both the European grid build-out and AI-driven electricity demand in the US — the First Trust NASDAQ Clean Edge Smart Grid Infrastructure Index Fund (NASDAQ:GRID) is worth considering.

The second group consists of sectors with relatively resilient earnings. Banks remain one of the more constructive parts of the market. A higher-for-longer rate environment can still help sustain net interest income and margins, particularly if rates stay elevated without tipping the region into a severe downturn. More importantly, European banks are no longer the structurally weak part of the market they once were. Profitability has improved materially, as shown by the continued earnings beats in recent quarters. Capital levels are stronger, and the sector is benefiting from a healthier earnings base than in the post-crisis years. Investors who wish to gain exposure to European banks sector may consider the Multi Units Luxembourg - Amundi STOXX Europe 600 Banks UCITS ETF Acc (LSE: CB5).

Healthcare also continues to be resilient. The investment case here is still centred on earnings resilience and visibility. Demand is less discretionary, business models are less exposed to swings in energy costs, and the sector tends to hold up better when the growth backdrop becomes less certain. In a market where investors are becoming more cautious on cyclical exposure, these characteristics become more valuable. Healthcare may not be the most exciting part of the market in a risk-on rally, but it remains one of the clearest anchors for the Europe investment case when macro conditions become more difficult.

Valuation offers a floor, not a catalyst

Valuation remains one of the more supportive elements of the Europe investment case. On our 2028 earnings estimates, the current market price implies a PE of 13.5x — a meaningful discount to our fair value estimate of 15x, and below the index's long-run historical average. That gap is the basis for our 11% upside projection to end-2028.

That said, earnings expectations carry downside risk under the current macro scenario, particularly for energy-sensitive sectors. The 11% upside should be viewed as conditional on a stabilisation in the macro environment rather than a guaranteed outcome.

We downgrade Europe from Attractive to Neutral. This reflects a wider distribution of outcomes rather than a fundamentally negative view.

• Upside scenario: Energy prices stabilise, inflation moderates, and policy becomes more supportive
• Downside scenario: Inflation re-accelerates, forcing tighter policy and further pressure on growth and earnings

In this environment, broad market exposure becomes less compelling, but selective positioning remains valid. Investors looking to maintain exposure may consider the Eastspring Investments Pan European Fund SGD, while a lower-cost option is the Vanguard FTSE Europe ETF (NYSE: VGK). For investors who prefer a European-listed, lower-cost alternative, the Amundi Core STOXX Europe 600 UCITS ETF Acc (LSE: MEUS) offers comparable broad European equity exposure and is worth considering alongside the options above.

Table 1: Projections for Stoxx 600 Index

Stoxx 600 Index	2025	2026E	2027E	2028E
EPS	35.75	37.89	41.72	46.42
EPS growth	0.28%	5.99%	10.11%	11.27%
PE Ratio	17.53	16.54	15.02	13.50
Upside Potential  (fair pe of 15x)	-	-	-	11.13%
Target Price  (EUR)	-	-	-	696
Dividend Yield	3.01%	3.16%	3.42%	3.72%
Source: Bloomberg Finance L.P., iFAST Estimates
Data as of 16 April 2026

Chart 4: Price projection for Stoxx 600 index.

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.

This research report was prepared with the assistance of artificial intelligence (AI) tools.  iFAST Financial Pte Ltd does not rely exclusively on AI for content generation; the content of this report – including all investment theses, ratings, price targets and conclusions – has been independently reviewed and verified by the research analyst(s) to ensure accuracy and professional integrity.