By Hilary Schmidt, International Banker
European equities completed the first half of 2026 with a powerful second-quarter (Q2) advance. The MSCI Europe Index, covering 397 large and mid-sized companies across 15 developed European markets, delivered a net total return of 10.75 percent in the six months to June 30, including 11.80 percent in Q2. The STOXX Europe 600 price index rose 10 percent during the quarter, its largest gain since October 2020. Improved earnings, global artificial intelligence (AI) investment, profitable banks, public spending and a sharp reversal in oil prices all proved crucial in generating strong market gains at different times during the period.
The headline return overstates the strength of Europe’s domestic corporate sector. The MSCI Europe Small Cap Index produced a net total return of only 5.41 percent during the first half, roughly half the large- and mid-cap index’s gain. STOXX estimated that nearly half of the Europe 600’s weighted revenues were earned outside Europe. Meanwhile, the European Commission (EC) forecasted in May that the European Union’s (EU) gross domestic product (GDP) would expand by only 1.1 percent in 2026. The rally has consequently reflected the earnings mix of listed companies more than the strength of the regional economy.
The composition of prominent market winners also changed during the year. By the end of February, major European indices had gained approximately 6 to 8 percent, led by basic resources, telecommunications, oil and gas, and utilities. The conflict in the Persian Gulf then raised energy costs, weakened travel and consumer shares and erased much of that advance. During Q2, technology recorded its strongest quarterly rise since 2001 as enthusiasm for AI infrastructure spread beyond the United States and Asia. A 38-percent fall in oil prices over the same quarter subsequently helped travel and leisure shares rise by more than 19 percent. The result was a sequence of sector rotations across the half-year.
Corporate profits also proved pivotal in laying the foundations for the strong market performance. The LSEG’s (London Stock Exchange Group) I/B/E/S data published on July 23 projected 17.3 percent year-on-year earnings growth for STOXX Europe 600 companies in Q2, based on results from 77 constituents, as well as analyst estimates for those yet to publish their results. Energy’s expected 122.6-percent increase contributed heavily, although earnings were still forecast to rise by 7.2 percent when excluding the energy sector. Revenue was projected to grow by 11.5 percent, the strongest rate since the final quarter of 2022 after 13 flat or declining quarters. The return of top-line growth made the profit recovery less reliant on cost reductions.
AI has provided Europe with an unexpectedly powerful growth route. Morgan Stanley estimated in early July that companies connected to AI capital expenditure accounted for around 70 percent of the MSCI Europe Index’s 2026 performance. The group extends from semiconductors to electrical networks, turbines, cooling equipment and data-centre components. ASML, the Dutch producer of lithography systems for advanced chips, was MSCI Europe’s largest constituent with a 5.43-percent weight on June 30. Its shares rose 60 percent during the year to July 20, boosting its market value to close to $700 billion. Its performance and index weight have helped greatly in leveraging the AI-dominated global technology cycle to contribute significantly to Europe’s market gains this year.
Europe’s industrial base helped to broaden that exposure, moreover. Infineon Technologies supplies power semiconductors, while Schneider Electric, Siemens Energy and Legrand sell distribution equipment, cooling systems and other data-centre hardware. Siemens Energy recorded €17.75 billion of orders during the three months to March 31—29.5 percent more than a year earlier—and ended the quarter with a record €154-billion backlog. “Our strong market momentum continues despite geopolitical uncertainty, leading to another exceptionally strong quarter and first half of the fiscal year,” Christian Bruch, Siemens Energy’s president and chief executive officer, said. Orders exceeding revenue by 72 percent carried demand into future sales.
Financial companies have represented another crucial European growth engine this year, particularly in Britain, Spain and Italy, with higher lending margins, loan volumes, fee income and trading revenue along with contained credit losses all supporting profits and shareholder distributions. Santander, for example, reported a 10-percent year-on-year increase in second-quarter net interest income to €11.69 billion, while its shares were 18 percent higher for the year by late July. “We’re seeing financials as the sector with the most guidance upgrades relative to downgrades,” Carolin Raab, European equity and cross-asset strategist at Deutsche Bank (DB), observed in February.
Government expenditure has further supported European stock markets this year, especially by turning defence and infrastructure themes into corporate orders. EU member states are expected to spend €454 billion on defence during 2026, 8.6 percent more than in 2025 and 75.3 percent more than in 2021. Thales Group reported €12.47 billion in first-half orders, a 21-percent annual increase that included 18 contracts worth more than €100 million each. German federal investment spending rose by 11.1 percent, or €2.3 billion, during the first six months, with defence, industrial and engineering companies positioned to supply military, transport, electricity and digital infrastructure.
Energy prices repeatedly altered which national markets and sectors led. Higher commodity prices initially favoured oil producers and miners, supporting the resource-heavy FTSE 100 Index, while expensive crude raised costs for airlines, manufacturers and households across continental Europe. The 38-percent Q2 fall in oil prices reversed much of that burden by reducing expected transport and production expenses, easing inflation pressure and supporting household purchasing power. “Lower oil prices strengthen the investment case for Europe, especially against an energy exporter such as the US,” András Vig, investment strategist at Invesco, recently told Reuters. “The overweight of cyclical sectors in Europe can also boost relative returns if input costs decline, inflation moderates and global economic growth re-accelerates.”
The relative valuation appeal of European indices should also not be ignored. On June 30, for instance, the MSCI Europe Index traded at 15 times forecast earnings and offered a 2.80-percent dividend yield, compared with 19.17 times and 1.52 percent, respectively, for the broader MSCI World Index. What’s more, the discount coincided with valuations that had already risen. “European equities aren’t cheap anymore, but they’re not expensive either,” Michael Field, Morningstar’s chief European equity strategist, explained in January. “That said, the margin of safety that investors had previously is gone.”
Europe also offers a less concentrated index structure. Its 10 largest MSCI constituents represented 21.68 percent of the benchmark at the end of June, with no company exceeding ASML’s 5.43 percent weight. “Simple answer is yes. It is much less concentrated than the US,” Sharon Bell, European portfolio strategist at Goldman Sachs Research, acknowledged. As such, more companies can contribute meaningfully to returns, although their earnings may still depend on widespread forces, such as AI expenditure, oil prices and interest rates.
Do such trends position European equity markets as an attractive investment destination, then? Not necessarily.
Do such trends position European equity markets as an attractive investment destination, then? Not necessarily. The week to June 19 saw European equity exchange-traded funds (ETFs) attract approximately $1.5 billion, according to Morningstar estimates cited by Reuters. This was the first net weekly gain in fund volumes after 10 consecutive weeks of withdrawals, indicating the persistent overall weakness in investor sentiment.
Part of that weakness might be attributed to still-underperforming segments of the market. Europe’s smaller companies have lagged, while automotive, luxury, media and parts of the software sector have faced weak Chinese demand, tariff impacts and/or possible AI disruption. And while semiconductor companies have reported strong results, rising valuations mean that share prices increasingly depend on whether earnings exceed already elevated expectations.
Investors are also questioning whether hyperscalers can generate sufficient revenue from AI services to sustain their enormous expenditures on chips, data-centre equipment and power infrastructure. Any slowdown in such spending could weaken growth across the semiconductor and AI infrastructure supply chain.
On the whole, this year’s strength in European equities has largely come off the back of their largest listed companies occupying several of the most powerful ongoing earnings cycles. Dutch technology; German and French power equipment; British, Spanish and Italian financials; European defence procurement and internationally generated revenues have supported profits despite subdued domestic growth and weaknesses in consumer-facing industries. Relatively attractive valuations and dividend opportunities have further supported this bullishness.
To sustain Europe’s positive market momentum going forward, however, key challenges will likely need to be mitigated. Budget commitments must continue to be transmitted into tangible orders; AI investment must generate durable supplier earnings; the quality of bank credit must remain undiminished; and energy costs must stay manageable.