Fidelity: The case for European equities
European equities have delivered strong returns, but the next phase is likely to be driven less by rising valuations and more by company fundamentals. We believe the strongest opportunities lie in companies capable of sustaining earnings growth, generating cash, allocating capital effectively, and maintaining durable competitive advantages that remain underappreciated by the market.
The next phase will reward fundamentals
European equities have delivered strong gains over the past three years, prompting some investors to ask whether the opportunity has largely passed. At Fidelity, we remain constructive, but we believe the investment case has evolved. Much of the market’s valuation recovery has already taken place; from here, success is likely to depend increasingly on identifying companies capable of delivering sustainable earnings growth, strong cash generation and disciplined capital allocation.
Recent gains have been supported by a more favourable policy backdrop, higher defence spending, and renewed confidence in European banks. Going forward, however, we expect returns to depend less on further valuation expansion and more on companies growing earnings, sustaining margins, converting earnings into cash and returning capital to shareholders. That should create a more differentiated market where stock selection will be key.
A broader earnings recovery is emerging
The most encouraging development is the improvement in earnings expectations. More analysts are now raising forecasts for European companies than cutting them, margins outside of the energy sector have moved to new highs, and the recovery is broadening beyond semiconductor and industrial-equipment companies into banks, utilities, transport and travel. Almost every major European sector is now expected to grow earnings this year, compared with a much more mixed picture last year. Importantly, this improvement is no longer confined to a relatively narrow group of companies or investment themes. Earnings momentum is becoming increasingly broad-based, creating a richer opportunity set for bottom-up investors.
We would not, however, expect a smooth or uniform recovery. The full effects of tariffs have yet to appear in many companies’ results. Higher energy and commodity costs could place renewed pressure on inflation and consumers, while Chinese competition remains a structural challenge for parts of European industry. German infrastructure spending is also likely to reach company order books gradually rather than immediately.
The earnings outlook is improving but remains uneven across sectors
Valuations have undoubtedly become less compelling than they were a year ago, but attractive opportunities remain. While parts of the market now look fully valued, European equities continue to trade at meaningful discounts to US peers across many sectors despite increasingly similar profitability and earnings prospects. The broad valuation opportunity has narrowed, but stock-level opportunities remain abundant. Our view is therefore positive but measured; the earnings backdrop is improving, although companies still need to translate stronger demand into sustainable profits and cash generation.
Europe is more global than it looks
European equities are often viewed as a proxy for the region's economy. In reality, the revenue exposure of the MSCI Europe Index is far more geographically diversified than its country composition might suggest. More than half of the revenues generated by European-listed companies come from outside Europe and the UK, giving investors access to a broad range of global growth drivers.
This diversification is broader than in the S&P 500. North America accounts for around 59% of S&P 500 revenues, compared with approximately 24% for MSCI Europe. By contrast, European companies have a more balanced exposure across continental Europe, emerging markets and North America, with emerging markets alone contributing around 30% of revenues.
European earnings are therefore influenced as much by global industrial activity, currencies, supply chains and international investment as by local economic growth. A subdued European economy does not automatically imply weak returns from European equities. For us, a company’s country of listing is only a starting point; what matters more is where its revenues and profits are generated and whether its competitive position is strengthening.
Finding the next generation of winners
Artificial intelligence is one area where we believe Europe remains underappreciated. Our analysts’ bottom-up, fundamental research suggests that around one in five MSCI Europe companies already has direct revenue exposure to AI-related activity, including important suppliers of semiconductor equipment, electrical systems, power management, cooling technology and industrial automation—the physical infrastructure needed to build data centres and support rising computing demand.
The next phase may be broader. Our analysts continue to identify opportunities among European companies that could use AI to automate workflows, improve pricing and risk assessment, and raise productivity. Banks, for example, have significant scope to automate labour-intensive compliance, onboarding and customer-service functions, while insurers can use AI to improve underwriting and claims analysis. These benefits may take longer to appear than spending on chips and data centres, but they could ultimately reach a much wider range of businesses and have a meaningful impact on margins and returns.
We are approaching this theme selectively. Some infrastructure companies have already risen sharply, while the impact on potential users remains difficult to quantify. We distinguish between businesses that may be disrupted and those with proprietary data, mission-critical systems, or embedded customer relationships. Broad labels such as "AI winner" and "AI loser" can be overly simplistic, grouping together companies with very different business models, competitive advantages and levels of exposure to disruption.
We focus instead on where a company’s value lies, how deeply its products are embedded in customers’ operations, whether it owns proprietary data, and how readily its services could be replaced. Some businesses currently viewed as potential losers may prove resilient - or even benefit from AI - while apparent winners may still disappoint if expectations and valuations run too far ahead of fundamentals.
Financials remain one of the areas where we continue to see attractive opportunities. European banks have spent years strengthening their balance sheets, cleaning up loan books, and improving returns. Dividends and buybacks remain important, while AI could create efficiencies in compliance, onboarding, and customer servicing.
But banks have already performed strongly, so we are not making a blanket call on the sector. We are focused on institutions that can sustain attractive returns, maintain sound credit quality, and allocate capital well. The structural case remains positive, but valuation matters more than it did.
Higher defence and infrastructure spending should also remain supportive, although here too selectivity is essential. In defence, we favour businesses with differentiated technology, long-term contracts, and strong cash conversion rather than simply those with the strongest near-term order momentum. In infrastructure, the opportunity reaches beyond construction into electricity networks, cables, transformers, power management and cooling systems, where policy spending, electrification and AI-related demand can reinforce one another.
This selectivity extends beyond larger companies. We continue to identify attractive opportunities among domestically oriented and smaller European businesses, reflecting bottom-up research into companies with strong balance sheets, scope to gain market share and valuations that leave room for recovery. Takeover activity has highlighted the gap between public-market prices and the value recognised by strategic or private-equity buyers. The recovery may take time, and companies with weak balance sheets or further earnings downgrades remain vulnerable.
Why stock selection matters more
The gap between the strongest and weakest European shares remains wide, and profit forecasts are moving in very different directions across companies and industries. This is precisely the type of environment in which active, research-driven investing has historically been most valuable.
Some defence, semiconductor, and power-infrastructure companies now need strong execution to justify their share prices. At the same time, a number of high-quality businesses have de-rated despite retaining resilient cash flows, strong balance sheets, and the ability to grow dividends. Broad thematic baskets can cause companies with very different fundamentals to move together, creating opportunities when the market fails to distinguish between them.
Our portfolio managers draw on the expertise of 381 dedicated European equity analysts, supported by Fidelity's wider global research network. We combine company meetings and detailed industry analysis with AI-enabled tools that help us interrogate our current and historic proprietary research. The aim is to build conviction where the market may be underestimating earnings, cash generation or long-term competitive advantage.
Looking ahead
The case for European equities is becoming more fundamental. Strong gains have raised expectations, while the earnings backdrop is improving. Europe offers global companies, attractive income, and exposure to financials, industrial technology, power infrastructure, and enterprise AI adoption.
The risks have not disappeared. Tariffs, energy prices, Chinese competition, fiscal execution, and weaker consumer demand could all challenge the outlook. But these pressures will affect companies very differently. We therefore do not see the opportunity as a simple call to buy Europe because it is cheap. Instead, we believe the next phase will reward investors who can identify businesses whose earnings, cash generation and competitive advantages remain underappreciated.
The broad valuation re-rating has largely taken place. From here, we believe success will depend increasingly on identifying companies capable of delivering sustainable earnings growth, disciplined capital allocation and durable competitive advantages. In our view, that creates a favourable environment for active investors able to distinguish between businesses whose prospects are genuinely improving and those where expectations have simply moved too far.
1As at 30 June 2026.
