Europe 4Q Outlook: More resilient than expected, but the risk-reward remains unattractive

• Economic resilience has improved, but consumption remains constrained. Activity continues to expand, while energy inflation, pressure on purchasing power and elevated saving intentions limit household spending.

• Stronger earnings support higher forecasts, but growth drivers vary in durability. The second-quarter recovery extended beyond Energy, although some cyclical sectors benefited from low bases and temporary supply-demand changes.

• We favour power infrastructure and defence, alongside selected technology leaders. AI-related capital expenditure, multi-year investment commitments, order backlogs support greater visibility into future earnings growth.

• Banks remain neutral and consumer discretionary remains negative. Bank earnings retain support, but valuations reflect substantial optimism; discretionary spending continues to face weak demand.

• We maintain Europe’s 2.0 Stars “Not Attractive” rating. Inflation and interest rate risks remain unresolved, while approximately 11% potential price upside through 2028 offers insufficient compensation. We see more compelling opportunities in other markets.

Europe’s economy and corporate earnings have performed better than we anticipated, supporting an upward revision to our earnings forecasts. However, the effects of recent rate hikes on consumption and investment have yet to be fully reflected. Prolonged geopolitical conflict and renewed oil price increases could sustain inflation and prompt further monetary tightening.

Macro: Resilient activity, but inflation and financing pressures persist

Economic activity has held up better than expected

Europe has proved more resilient to the energy shock than we previously expected. Eurozone GDP continued to grow in the second quarter, while the Composite PMI recovered from 48.5 in May to 52.0 in August, with both manufacturing and services returning to expansion. These readings suggest that higher energy prices have not triggered a broad contraction in activity, supporting a more constructive assessment of near-term growth.

Nevertheless, continued expansion does not mean that the energy shock has subsided. The year-to-date movements in Brent crude and European TTF natural gas prices illustrate the scale and persistence of the cost pressures facing businesses and households.

Chart 1: Brent crude and TTF natural gas prices remain well above their end-2025 levels.

Purchasing power and spending intentions remain under pressure

Despite resilient activity, households face growing pressure on purchasing power. Headline inflation rose from 1.7% in January to 3.2% in August, above the 2.44% negotiated wage growth recorded in the second quarter, the latest available reading. If wage growth stays near that pace, rising inflation will continue to erode purchasing power. Consumption has also weakened: annual growth in retail sales volumes slowed from 2.0% in May to 0.6% in July.

Forward-looking indicators offer little evidence of an imminent recovery in spending. Although consumer confidence has improved from its April low, this has yet to translate into stronger spending intentions. In August, intentions to make major purchases were broadly unchanged, while saving intentions approached their highest recorded level. Household inflation expectations also rose markedly, suggesting that caution continues to constrain spending.

With energy prices elevated and geopolitical uncertainty unresolved, households appear more inclined to build precautionary savings than bring spending forward. Persistent inflation would therefore remain a headwind to consumption.

Further tightening remains a risk

Rising inflation expectations also strengthen the case for the European Central Bank to guard against second-round effects. So far, evidence of broader inflation transmission remains limited: core inflation eased from 2.5% in July to 2.4% in August, while negotiated wage growth has remained relatively moderate, without clear signs of substantial wage catch-up. The ECB’s June and September rate hikes therefore appear largely precautionary.

However, the longer energy prices remain elevated, the greater the risk that businesses pass on higher costs and workers seek compensating wage increases. Rising household inflation expectations are an early warning of this potential transmission.

Market pricing also points to further tightening. As of 1 October, markets were pricing in another rate hike by year-end and nearly four hikes in total by September 2027, which would bring the deposit rate to around 3.4%. These expectations are not an ECB commitment, but they indicate that markets do not anticipate a rapid return to monetary easing.

Chart 2: Markets now price the ECB deposit rate rising to around 3.4% by September 2027.

Regardless of whether further hikes materialise, recent tightening will continue to feed through to the economy. Higher financing costs should gradually affect household borrowing and corporate investment over the coming quarters, with additional hikes deepening these constraints. Persistent energy inflation also limits the scope for easing. We therefore acknowledge Europe’s resilience while remaining cautious about the durability of the recovery.

Earnings: A broader recovery, but uneven sustainability

Overseas demand and cost management provide support

Corporate revenue and earnings growth have exceeded expectations. STOXX Europe 600 Index earnings growth accelerated from 11.8% year on year in the first quarter to 25.3% in the second. Energy made the largest contribution, with earnings rising approximately 124%, partly reflecting relatively low oil prices a year earlier. Excluding Energy, however, earnings still increased by 7.1% and 15.3%, respectively. The improvement therefore extended beyond direct beneficiaries of higher energy prices.

Two factors help explain why index earnings can diverge from domestic economic conditions. First, approximately 60% of constituent revenues come from outside Europe, allowing overseas demand to partly offset weak local consumption. Second, energy hedging, price increases, cost reductions and supply-chain adjustments have helped companies cushion the impact of higher energy costs on margins.

Both buffers have limits. Overseas operations introduce currency and trade-policy exposure, while prolonged energy inflation could gradually weaken companies’ ability to absorb cost increases.

Cyclical earnings rebounds should not be extrapolated

The recovery broadened across sectors, but its sustainability remains uneven. Second-quarter earnings rose by 22.7% in Financials and 18.7% in Industrials, while Consumer Discretionary earnings declined by 7.5% and Healthcare grew just 1.9%. Stronger aggregate earnings have therefore not coincided with a uniform improvement in underlying demand.

Current growth broadly reflects three sources: price-driven cyclical gains, particularly in Energy; recoveries supported by low bases, restocking and improved spreads, including Materials; and structural growth underpinned by multi-year orders and investment commitments, including defence, power infrastructure and selected technology companies. The first two can generate strong near-term rebounds, but depend more heavily on changing supply-demand conditions. The third offers greater demand visibility.

Chemicals illustrates this distinction. Earnings growth substantially exceeded revenue growth, supported by depressed prior-year margins, pricing gains following supply disruptions among Asian and Middle Eastern competitors, and higher volumes and utilisation at some leading companies. Restructuring savings also reduced costs, while one-off gains and lower tax rates amplified EPS growth. The improvement was concentrated in a few cyclical leaders.

Many of these benefits may prove temporary. Europe’s gas-cost disadvantage relative to the US persists, while industry demand remains weak. EU chemical production fell 1.6% year on year in the first half of 2026, and capacity utilisation was approximately 75%, well below its long-term average of 81.3%.

As global supply recovers, additional output could put pressure on prices and orders. Expiring gas hedges could also expose companies to higher costs: TTF prices have risen from approximately EUR 33/MWh at end-June to around EUR 72/MWh. Second-quarter earnings should therefore not be extrapolated, and earnings growth faces the risk of turning negative in 2027.

Sector positioning: Prioritising structural demand

Power infrastructure and Defence: Multi-year demand support

Within Europe, we favour sectors with more durable demand and clearer paths to earnings growth. Power infrastructure benefits from investment needs that extend beyond the AI spending cycle. Connecting new data centres requires grid capacity, while ageing network replacement and broader electrification create additional demand for transmission and distribution investment. These needs support multi-year spending programmes, providing greater visibility than a recovery dependent on discretionary consumption.

For regulated utilities, approved capital expenditure can expand the regulated asset base and support future earnings. Actual returns nevertheless depend on financing costs and regulatory allowances. For equipment and infrastructure suppliers, the key is converting demand into orders and subsequently delivering revenue and profit growth. We participate in these opportunities through the First Trust Nasdaq Clean Edge Smart Grid Infrastructure Index Fund (NASDAQ: GRID).

Defence demand also has a multi-year foundation. Europe’s commitment to strengthening military capabilities and increasing defence expenditure creates sustained order opportunities. Importantly, orders are already translating into operating results: companies in the underlying index of the WisdomTree Europe Defence UCITS ETF (LSE: WDEF) recorded double-digit revenue and EPS growth in the first half, while all ten largest holdings improved their core margins. Backlogs and operating performance support our Positive view. Capacity expansion and delivery execution remain the main factors to monitor.

Technology: Selecting companies with critical competitive advantages

Europe’s semiconductor strengths include ASML’s unique position as the sole supplier of EUV lithography systems and Infineon’s power semiconductor expertise for AI data centres. Both offer exposure to infrastructure investment and technological upgrades, with less reliance on any single AI chip designer.

Demand visibility also provides support. ASML reported that its 2027 Low-NA EUV capacity was close to fully covered by orders, while Infineon has signed multi-year capacity reservation agreements with leading AI customers. Delivery execution and the pace of customer investment remain key risks.

In software, SAP’s second-quarter cloud revenue and current cloud backlog grew by 24% and 26%, respectively, at constant currencies, supporting its cloud transition.

Banks and Consumer Discretionary: Different constraints on returns

We maintain a Neutral view on Banks. Net interest income remains the main revenue source. Improving corporate loan demand is largely driven by large companies, while demand from SMEs and for housing loans remains weak. The spread proxy between new lending and deposit rates has also narrowed, offering limited evidence that rate hikes are generating stronger incremental income growth.

Fee income provides additional support through trading, wealth management and M&A-related activity. European bank consolidation could generate synergies, but increases in deal value are concentrated in large transactions. Antitrust scrutiny and structural barriers to cross-border integration continue to constrain opportunities.

Valuations already reflect substantial optimism. The sector’s price-to-book ratio is close to three standard deviations above its ten-year average, while its discount to US peers has narrowed from a ten-year average of 17% to approximately 4%. Earnings can continue to support share prices, but further gains require growth to exceed increasingly demanding expectations.

Consumer Discretionary remains Negative. Pressure on purchasing power, slowing retail sales and elevated saving intentions continue to constrain demand for cars and other discretionary purchases. We retain our cautious stance until spending intentions show a clearer recovery.

Valuation: Higher earnings forecasts, but insufficient compensation for risk

Our updated forecasts project STOXX 600 EPS growth of 13.29%, 7.41% and 8.05% in 2026, 2027 and 2028, respectively, reflecting stronger recent earnings. Maintaining our fair-value P/E multiple of 15 times gives a 2028 target of EUR 705, approximately 11% above the market level. Higher earnings lift our target value, but current prices limit the remaining upside. The expected dividend yield stays above 3% through 2028, providing additional holding-period income.

Nevertheless, inflation and monetary tightening remain important forward-looking risks, and the potential return offers insufficient compensation to justify a higher rating.

By comparison, we believe opportunities such as Asian semiconductors offer a more compelling combination of structural growth and valuation.

We therefore maintain Europe’s 2.0 Stars “Not Attractive” rating and focus our European exposure on selected Defence and power infrastructure companies, where multi-year demand and orders are translating into earnings.

Investors looking to maintain exposure may consider the M&G (Lux) European Strategic Value A Inc EUR. 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.

Table 1: Our forecasts imply around 11% price upside for the STOXX 600 by FY2028.

STOXX 600 Index	FY2025	FY2026E	FY2027E	FY2028E
PE Ratio (x)	17.8	15.7	14.6	13.5
Earnings Growth	0.28%	13.29%	7.41%	8.05%
EPS	35.75	40.50	43.50	47.00
Dividend Yield	3.01%	3.16%	3.44%	3.74%
Target Price (EUR) (Based on fair PE ratio of 15x)				705
Potential Upside (%)				11%

Source: Bloomberg Finance L.P., iFAST Estimates Data as of 30 September 2026

Chart 3: The STOXX 600 has tracked earnings over time, and we project EPS to keep rising through 2028.

Declaration

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.

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