Solid 2025 for Euro stocks augurs well for 2026

Medium-term catalysts set to support market

Although it is never plain sailing in Europe, there are clear signs of improvement, and it may not be too late for investors to benefit.

Before we look forward to 2026, let’s take a brief look back at a remarkable 2025 for European markets. Why “remarkable”? Because while the returns in absolute terms might best be described as “not bad” this year, in relative terms – that is, for European stocks – “not bad” is actually very good. In local currency, the benchmark Stoxx Europe 600 Index was up 14% to the end of November and substantially higher than that in Canadian dollar (CAD) terms, at 24.6%, which is attributable to the weakness of CAD. Relative to the U.S., European equities outperformed, although again most of this outperformance has been the result of weakness in the U.S. dollar.

Still, for a market that has long been a laggard in global equity markets, a solid 2025 has been a refreshing change. And the key message here is that we believe investors who are just starting to look at Europe have not left it too late. The changes that began in 2024 and early 2025 are progressing as hoped.

A total of eight interest rates cuts by the European Central Bank (ECB) have boosted economic activity. In September, the ECB said it expects Europe to grow by 1.2% in 2025, compared to the 0.9% it forecasts for this year in June. While some of this was driven by corporations front-loading exports ahead of the implementation of Trump tariffs, the underlying signs of economic improvement are clear, as purchasing managers sentiment indices are consistently in expansionary territory and retail consumer spending is growing at 2.5% annualized.

Medium-term catalysts

This is before several expected medium-term catalysts kick in in 2026. These centre around the restructuring of Germany’s “debt brake,” which should allow the government to substantially increase investment in infrastructure and defence spending.

An early proof point was the opening of Europe’s largest munitions factory, in August of 2025, in northern Germany, a high-profile event attended by the head of North Atlantic Treaty Organization (NATO), the German defence minister, and the German vice-chancellor. Germany can afford this higher defence spending given the strength of its balance sheet.

The European Commission is also providing cheap financing, through its so-called Security Action for Europe (SAFE) program, for other European countries to ramp up their spending. SAFE will provide €150 billion (about CAD$240 billion) in competitively priced, long-maturity loans to member states requesting financial assistance for investments in defence capabilities. The impact will trickle down across Europe, and France, which has by far the largest defence industry on the Continent, will be one of the main beneficiaries.

After decades of under-investment, the ramp-up needed in German infrastructure is also staggering. Consider railways alone: It is estimated that €80 billion (CAD$130 billion) is needed for immediate repairs to Germany’s existing network, and a further €70 billion (CAD$113 billion) for new route construction and expansion, to help decarbonize the transportation sector. These projects are expected to be outlined in the second half of 2026 and will benefit industrial companies across Europe for years to come.

There has also been surprisingly fast acceptance of the region’s need to change “the way we do business,” as outlined by former Italian Prime Minister (and former ECB president) Mario Draghi in September 2024 in his report “The Future of European Competitiveness.” According to Apollo Global Management and the European Policy Innovation Council, upwards of 77% of Draghi’s proposals have been implemented, partially implemented, or are in progress. The fact that the European Commission decided this past September to publish a follow-up called “One Year After The Draghi Report: What has been achieved and what has changed,” is a testament to how seriously politicians are taking this initiative.

Investment implications

Despite the advancement of the short-term, medium-term and long-term catalysts seen during 2025, the short-term earnings performance of European equities was poor, with a number of sectors, especially autos, materials, and energy, dampening the growth of the market as a whole. This meant that any performance generated was the result of investors paying higher prices for the same earnings (i.e., multiple expansion).

Europe equity valuations have increased in absolute terms, and at the end of the third quarter of 2025 sat at 14.6 times forward earnings. While higher than the extreme valuation lows seen in 2024, the market still sits largely in line with long-run average valuation levels, which do not reflect the potential growth opportunity.

Another factor that has held European markets back in 2025 is politics, both internal and geopolitical. The ongoing budget deficit squabbles in France (resulting in a revolving door appointment of prime ministers), the collapse of the government in the Netherlands, and divisive election results in Poland were top-of-mind domestically. Tariff pressure from the U.S. government and the ongoing conflicts in Ukraine and Gaza also impacted sentiment. Going into 2026, the resolution of any of those issues would help to reduce the risk premium currently associated with the region.

Although it is never plain sailing in Europe, there are clear signs of improvement, and it may not be too late for investors to benefit. An initial flurry of global interest in European markets early last year gave way to the U.S. equity rebound, a potential turnaround in China, and hope of a revival of Abenomics in Japan under a new prime minister, but 2025 looks like it will be the first time in seven years that European equities will outperform global equities. There is still a lot of ground to make up, but you have to start somewhere.

Richard McGrath, M.Sc., CFA^®, Portfolio Advisor, AGF International Advisors Company Ltd. at AGF Management Ltd.

Notes and Disclaimer

© 2025 by AGF Ltd. The original version of this article first appeared in “The Outlook 2026: The Forecast for the Year Ahead,” published on the AGF website. Used with permission.

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