Investors are at best lukewarm when it comes to Europe. True, European equities outperformed the US market in 2025, but Europe has been a source of recurring disappointment. However, we think repeated false dawns and renewed uncertainty relating to the US-Iran war should not stop investors from considering what could go right over the medium term. From a multi-asset perspective, the investment case centres on Europe’s slowly improving fortunes after a long period of subpar growth but also the diversification opportunity the region offers, given an overly concentrated US market and deteriorating US institutional framework.
And while Europe remains fragile in several areas, as the growing fall-out from the US-Iran conflict once again illustrates, I observe tentative signs that Europe is getting serious about the need to implement much-delayed reforms.
Regime change
Europe is shedding the deflationary mindset that has prevailed for over a decade as it aims to reduce its dependence on export-led growth. Parts of Southern Europe are now leading the improving cycle, while Germany’s pivotal shift away from fiscal restraint is symptomatic of a broader European move towards security-, infrastructure- and productivity-related investment. This shift matters because it supports nominal growth and pricing power.
To date, Europe’s accelerating regime change has been aided by a more positive macro picture. While the surge in energy prices caused by Middle East conflict is clearly inflationary, I still see inflation stabilising longer term provided the duration and intensity of the supply shock is contained. Growth is supported by a more expansionary fiscal stance (with potentially more to come) and low unemployment. In addition, even allowing for some monetary tightening, overall financial conditions remain relatively loose. External headwinds, including, US tariffs, the war in Ukraine and now the Middle East conflict, have, so far, been manageable and may ultimately accelerate regime change. It is also worth noting that unlike the Ukraine war, the current conflict impacts energy prices, rather than supply, and will likely lead to further efforts to improve energy independence in ways that can lead to opportunities for investors.
Productivity gains through AI
Although Europe is not leading the AI race, the next stage of AI development is not just about who builds the technology, but who uses it effectively. And according to Microsoft’s latest AI Diffusion Report1, Europe is well ahead in adoption.
Many European companies are large incumbents with data, scale and established customer bases that can be harnessed. For them, AI is less about disruption and more about improving efficiency, reducing costs and supporting margins.
Pricing power is the important variable to watch here. Companies that can adopt AI while maintaining pricing discipline are more likely to translate productivity gains into earnings. Over time, this could become a positive for Europe, especially given the relatively low starting point.
Increasing strategic autonomy and competitiveness
Europe appears now increasingly committed to increase both its strategic autonomy and competitiveness. Mario Draghi’s report on “The future of European competitiveness”2 is critical here. The former president of the European Central Bank highlights well-known weaknesses but frames them as urgent economic risks rather than long-term aspirations. Any acceleration in implementing Draghi’s recommendations would materially improve the region’s prospects.
Areas with the greatest potential include reducing Europe’s energy dependency, strengthening the internal market, concluding outstanding trade deals as well as mobilising savings into more productive investment.
I would also not discount the potential of a durable ceasefire in Ukraine, even if it currently appears unlikely given Russia’s maximalist demands.
On the downside, Europe still face significant headwinds. In addition to monitoring events in the Middle East, keep a close eye on:
Intensifying global competition, especially from Chinese manufacturers, is one of the most underestimated hurdles for European earnings. With Europe’s equity markets heavily exposed to mature industrial sectors, even the indirect impact on pricing and market share can constrain earnings..
A rapidly ageing population is increasingly affecting public finances and curbing labour supply. Public finance constraints could limit necessary investment, while labour shortages may translate into higher inflation and reduce competitiveness. AI could be an important variable in helping to mitigate this risk.
The key takeaway for me is to monitor marginal improvements that could yield significant medium-term upside. Japan offers a promising parallel. Like Europe, Japan has suffered from repeated setbacks and prolonged negative sentiment. However, a combination of improving factors has created positive momentum. Looking through the current uncertainty and risks, I believe that even small steps by Europe could create micro tailwinds akin to those underway in Japan. Moreover, ongoing regime change comes with significant divergence that active approaches can exploit.
1“Global AI adoption in 2025”, Microsoft AI Economy Institute, 8 January 2026. | 2Mario Draghi “The future of European competitiveness”, European Commission, September 2024. |3“The Single Market: our European home market in an uncertain world”, European Commission, 21 May 2025.
