Equity Strategy: Updating on key market themes
We maintain a positive stance on the equity market, expecting continued supportive Growth - Inflation tradeoff, with corporate earnings a tailwind. Internal participation is broadening, and Cyclical sectors are likely to keep rallying. We look for new highs at index level into year end, including for SXXP. In this report, we refresh our thematic positioning, with focus on Europe.
- Reflecting global trends, Europe as well is attempting to move from an efficiency and economies of scale targeting model toward a greater focus on security, resiliency, and strategic autonomy. This is driven by continued geopolitical uncertainty, from Ukraine to Middle East, a more transactional US policy stance, and intensifying China competition. The implication for markets is a longer lasting policy supported capex cycle that spans defence, energy systems, grids, industrial capacity, digital infrastructure, and selected critical supply chains. Relative to the US, Europe starts from deeper underinvestment in defence readiness, grid build, and industrial capacity, so the catch up could be meaningful. We address the following thematic groups: 1) Energy security, Grid upgrade, Renewables and Nuclear. The post-REPower EU drive to cut strategic energy dependence, alongside critical raw materials and net zero industry measures, is actively pushing domestic capacity higher.
- 2) German fiscal expansion and Infrastructure upgrade. Germany's constitutional debt-brake release has unlocked greater funding for defence and infrastructure projects, anchored by the EUR 500bn special infrastructure and climate fund.
- 3) Strategic Technologies. The focus is on AI buildout & industrial automation.
- 4) Defense Modernization. Rising NATO spending commitments and EUlevel joint procurement and defense-industrial initiatives, such as ReArm Europe / EDIP-type programs and common munitions replenishment contracts. In terms of our stance on the Defense sector, ever since last summer we have been arguing for a rollover, given that the theme became overowned, and have in our February Thematic update continued with a more cautious view on Defense, preferring Banks - see report. Given that Defense stocks spent more than a year struggling to perform - bottom chart, and saw a meaningful derating, we believe that risk-reward for the group is turning better going forward, but with a focus on new capabilities, rather than on legacy businesses.
- 5) Increased EU protectionism. On protectionism and sovereignty, Europe's preference for standards and regulation over simple tariffs is already visible in the Carbon Border Adjustment Mechanism (CBAM), local content requirements in wind, grids, defense, foreign subsidy screening, and antisubsidy actions on EVs, solar and wind.
- Out of other potential themes, even as they might not be a focus in the short term, we mention Aging Population and Ukraine Reconstruction and Eastern European Buildout. Across all seven groups, the physical infrastructure layer is the most investable, with Capital Goods (electricals/cables), Utilities, Building Materials, and Steel recurring as common beneficiaries. Taken together, the concrete policy anchors reinforce the duration argument: multiyear budgets, procurement, and regulation, rather than a single cycle.
Updating on key market themes
Equity markets are at fresh all-time highs, successfully navigating a range of geopolitical and rotation headwinds, as we hoped for. MSCI AC World is up approximately 14% ytd in total return terms. We believe stocks are likely to keep making fresh all-time highs in 2H, supported by robust earnings delivery and investor positioning that remains far from extreme.
Beneath the index, participation is broadening away from a narrow set of leaders, and we look for Cyclicals to keep leading. Market breadth fell to exceptionally narrow levels earlier this year, with only about 25% of MSCI AC World constituents outperforming the index at the recent low, before recovering to just above 40%. If breadth continues to normalize, index performance can be sustained even as prior leaders consolidate, as marginal demand rotates into laggards rather than leaving the asset class entirely.
Cyclical sectors are strongly outperforming in 2026, with European Cyclicals ahead of Defensives by approximately 10% ytd and US Cyclicals leading by around 12%. Importantly, the leadership holds even when stripping out Tech and AI exposures, suggesting it is not merely a function of the narrow AI trade.
With the tactical Low Vol bounce having run its course, we expect beta to resume rallying, and we view the thematic groups below as the most durable expression of that Cyclical preference.
We continue to target fresh index highs into year end. The earnings tailwind underpinning our stance is clearest in Europe, where we expect Eurozone EPS growth of 18% in '26 and 12% in '27. We have recently upgraded our European index targets on the combination of strong earnings delivery, improving breadth, and the prospect of easing financial conditions.
In this report, we refresh our thematic framework, with the focus on Europe, where a structural shift from an efficiency and economies of scale model toward security, resiliency, and strategic autonomy is reshaping the multi-year capital spending outlook. This follows a similar report from our U.S. team - see here.
The structural shift from efficiency to resilience
Reflecting a global trend, Europe too is attempting to move from a model that targeted efficiency and economies of scale toward one that prioritizes security, resiliency, and strategic autonomy. This is driven by continued geopolitical uncertainty, from Ukraine to the Middle East, a more transactional US policy stance, and intensifying competition from China. The market implication is a longer lasting, policy supported capex cycle spanning defence, energy systems, grids, industrial capacity, digital infrastructure, and selected critical supply chains. Because Europe starts from a deeper underinvestment in defence readiness, grid build, and industrial capacity relative to the US, the catch up could be meaningful and multiyear in nature.
We believe the investment gap is the single most important framing for this opportunity. Europe has under-invested in physical and strategic capacity for over a decade, and the policy response now underway is designed to close that gap. Unlike a conventional cyclical upswing, the drivers here are multi-year budgets, procurement commitments, and regulation, which extend the duration of the spend well beyond a single cycle.
The policy impulse in Europe is scattered across a range of programs and sectors. The presence of multiple programs creates overlapping multi-year commitments to fund the physical infrastructure. We have identified five thematic categories that stand to benefit from this sustained, multi-year shift.
1) Energy security, grid upgrade, renewables and nuclear
Energy security has become a critical priority as power demand accelerates sharply, driven by hyperscalers, AI data centers, electrification, and industrial reshoring. In Europe, the issue became even more urgent following Russia’s invasion of Ukraine, which exposed the region’s dependence on imported energy and forced a rapid rethink of gas supply, storage, LNG infrastructure, and grid resilience. At the same time, instability in the Middle East has reinforced the risks around global energy flows and price volatility. For European governments and companies, securing reliable and affordable energy is now a strategic requirement, not only to support rising demand, but also to protect industrial competitiveness, digital infrastructure, and broader economic resilience.
The post REPowerEU drive to cut strategic energy dependence, alongside the Critical Raw Materials Act and Net Zero Industry Act, is actively supporting domestic capacity. We believe this is the most mature of the five themes, with policy having shifted from ambition to implementation. The result is a sustained demand pull for grid equipment and renewables build.
In our view, investment in the power grid is one of the most overlooked challenges in the energy transition. Renewable energy projects cannot connect to the grid, and electrification cannot move forward, without major upgrades to transmission and distribution networks.
We see this creating steady demand over the next decade for Capital Goods companies that make electrical equipment and cables, as well as for the regulated Utilities that own the networks. This supports our Overweight view on Capital Goods and our positive view of the electrification supply chain.
Beyond the grid, the buildout of renewable energy infrastructure is the other major opportunity in this space. The strategy will likely center on expanding wind and solar capacity.
For a decade the political direction was to close nuclear plants, but the energy shock changed the calculation. Governments realised that renewables alone cannot guarantee power when the wind does not blow and the sun does not shine, and that importing gas is the very dependence they are trying to escape. Nuclear solves both problems at once. It is domestic and it runs around the clock, which is exactly what “energy security” requires. In the last few years, several countries have reversed course, extending plant lives and backing new builds.
These shifts have collectively helped stem the decline in nuclear power generation across the region, and we expect output to recover from here.
Major economies including France and the UK are committing tens of billions to new reactor construction and SMR development, while transitional markets such as Italy are establishing the legal frameworks to bring nuclear back online, targeting 11–22% of energy demand by 2050.
The nuclear exposed names have underperformed the market this year and could start trading better if the theme gets traction once again.
Looking at committed spend into energy generation, the Hydrogen related allocation stands out. However, we believe a large portion of this is likely to focus on pipelines and other supporting infrastructure, rather than core generation itself.
More broadly, we would frame the opportunity across the value chain rather than a single sub-sector. The electricals and cables complex within Capital Goods offers the cleanest read on grid spend, while regulated Utilities offer a lower beta way to participate.
2) German fiscal expansion and infrastructure upgrade
Over the last few decades, Germany, and much of Europe, spent the efficiency era under-investing in its own physical base. German public investment ran well below the euro-area average and below estimated replacement needs for much of the past decade, the net public capital stock was broadly stagnant or declining in real terms through the 2010s, resulting in an infrastructure backlog across roads, rail, bridges, schools etc. Digital and grid build lagged peers on both coverage and capacity. Given the chronic shortfall, the duration of catch-up spending is not a cyclical top-up but the repair of years of deferred maintenance and modernization.
Germany’s structural primary deficit is set to widen from -0.6% of GDP in 2025 to -2.2% in 2026 and -2.6% in 2027, a fiscal easing of approximately 2% of GDP over two years. The total federal deficit, including Special Funds, is projected to remain at around 4% of GDP through 2030. This is a meaningful shift. Markets have largely faded the German stimulus trade since Q1, and we think that is a mistake. The €500bn infrastructure fund is real, and the issue so far has been timing and planning rather than commitment.
The 2026 trajectory is beginning to diverge meaningfully from prior years. Finance Ministry estimates suggest spending from the Special Fund for Infrastructure and Climate Neutrality alone could lift GDP by 0.5%.
For context, the US Infrastructure Investment Jobs Act authorized $1.2tn of funding in 2021 yet is only now in peak execution phase. The transition from appropriations to outlays has effectively taken five years. European corporates with US exposure are seeing the revenue uplift today. The lesson for Europe’s own infrastructure cycle is that the gap between political commitment and earnings delivery is long, but once it arrives, it is likely to persist for years. We believe Europe is approaching the early stages of that inflection.
Early signs of fiscal acceleration are emerging. By June 2026, the cumulative federal deficit was already €12bn wider than at the same point last year, representing half of the full year widening implied by the 2026 budget.
We are seeing an inflection in total domestic orders ex-bulk, indicating a broad-based demand recovery beyond just defence procurement. This is an encouraging sign that the fiscal impulse is feeding through into the real economy.
The Eurozone economic surprise index is at elevated levels, reflecting recent data prints coming in better than consensus expected, while the Manufacturing PMI has been improving. We see the fiscal impulse as one of the factors behind this firming in the macro data, and expect the flow through to Industrials, building materials, and construction to become more visible in earnings over the coming quarters.
Germany’s fiscal spending plans should create a broad set of beneficiaries across the real economy, with the most direct impact in transport, digital infrastructure, grid investment, industrial upgrading, and housing retrofit. Transport spending on rail, bridges, and roads should support EPC contractors, engineering firms, and suppliers of aggregates, cement, and machinery. Digital investment in fibre and network upgrades should benefit telecom operators and contractors, while also creating second-order demand for power management and data centre supply chains. Grid spending on transmission and distribution is particularly important for cables, switchgear, and transformer manufacturers, with additional opportunities in software, metering, and storage. Industrial upgrade programs should support automation, drives, and controls, while housing and retrofit spending should benefit construction materials, heat pumps, insulation, and broader electrification suppliers.
Our Eurozone fiscal stimulus basket includes companies expected to benefit from an acceleration in fiscal spending across the region. This basket focuses on firms likely to see increased demand for their products and services as government investment boosts infrastructure, public works, and economic activity throughout Eurozone. The basket was compiled using inputs from European Equity Research sector analysts.
3) Strategic technologies
Europe’s strategic technology opportunity is not the same as the U.S. playbook. The U.S. is more exposed to consumer platforms, hyperscale cloud, frontier AI platforms, and megacap software ecosystems. Europe’s strongest positions are more upstream and industrial, i.e. semiconductor equipment, industrial automation, sensors, defence technologies, industrial software and power electronics.
AI capex has scaled dramatically, and our Tech analysts continue to expect this wave of spending to be sustained beyond 2026, benefitting the entire semiconductor value chain. For Europe, the strategic technologies theme centres on AI buildout and supply chain independence, where the region hosts globally critical assets in semiconductor equipment even as it seeks to reduce external dependence.
An increasing gap has opened between Semis price relative and earnings relative, with the stocks having rolled over despite continued earnings resilience. With fundamentals staying strong and meaningful supply additions not due before 2028, we think investors should add to the space, and we retain our Overweight on Semis. We would, however, distinguish the strategic buildout from the AI cannibalisation groups, staying fundamentally cautious on Software, Business Services, and Media.
Our global Tech team points to structural DRAM/NAND supply demand tightness extending through 2028, with surging AI and server driven demand keeping conventional supply tight. We continue to view the EM memory trade as having legs and stay Overweight EM equities, but for European portfolios the cleaner exposure is via the semiconductor equipment and Technology Hardware names, where we hold an Overweight.
In addition to semiconductors, several other sectors also show a genuine competitive edge. In telecom infrastructure, Ericsson (wireless/RAN) and Nokia (optical and networking) give the bloc rare end-to-end capability, while Siemens leads in industrial AI and software-defined automation.
The EU also demonstrates strength in photonics and optical connectivity (Halma) and quantum and compound-semiconductor enablement (Oxford Instruments), as well as AIenabled life sciences tools, led by Sartorius, Sartorius Stedim
Biotech and Oxford Nanopore. Finally, in satellite communications, Eutelsat and SES underpin the EU's sovereign connectivity ambitions through the strategically important IRIS2 constellation programme.
4) Defence modernization
Defence is the clearest example of Europe moving from efficiency to resilience. For years, Europe underinvested in readiness, inventories, munitions, air defence, and sustainment. The Russia-Ukraine war changed the policy baseline.
Many European NATO members spent below the 2% of GDP guideline. The post-Cold-War "peace dividend" saw real defence budgets drift lower over decades, munitions stockpiles were run down faster than they were replenished, and equipment readiness across several fleets sat at low availability. Procurement was fragmented across national programs, limiting scale and slowing capacity build.
Rising NATO spending commitments and EU-level joint procurement, including ReArm Europe and EDIP-type programs and common munitions replenishment contracts, provide a durable demand backdrop for the sector.
After a multi-year positive view on the Defence sector, we turned cautious last summer. We argued for a rollover as the theme became crowded, and in our February Thematic update we retained a more cautious view on Defence.
With Defence having derated meaningfully, we believe the risk/reward for the group will turn better going forward. Our preference, though, is for new capabilities rather than legacy platforms, i.e. drones, electronic warfare, munitions replenishment, and space, rather than legacy warships or heavy armoured vehicles. We would use the de-rating as an opportunity to rebuild exposure selectively rather than chase the sector wholesale.
Investors have increasingly framed the sector opportunity as a capability-driven barbell. Companies exposed to missiles, drones, and air defence systems have seen share prices and multiples rise sharply, while legacy heavy-platform franchises have lagged following the earlier rally.
This selective approach is consistent with our broader preference for Cyclicals with genuine earnings delivery over crowded thematic exposure.
If Europe wants more defence production, it needs more automation, machine tools, testing equipment, components, power systems, and industrial software. It connects defence directly to Capital Goods.
The list above of European defense plays includes stocks that are significantly exposed to the European defense sector. The basket includes firms that stand to benefit from a structural shift in government policy, as European countries move to reverse decades of under-investment in defense and security.
Modern defense names include Hensoldt (N), Leonardo (OW), and Saab (Not Covered), focused on radars and sensors (with Saab also in airborne early-warning aircraft and naval platforms), alongside Thales (N) and BAE Systems (OW), which offer broader air-defence suites spanning radars, C2, electronic warfare/jamming, and missiles. Kongsberg Defence (Not Covered) is present in missiles and missile systems, Exosens (OW) in image-intensifier tubes and optics for night vision and drones, and OHB (OW) in satellites for European institutions and the German military.
5) Increased EU protectionism
On protectionism and sovereignty, Europe's preference for standards and regulation over simple tariffs is already visible. The Carbon Border Adjustment Mechanism (CBAM), local content requirements in wind, grids, and defence, foreign subsidy screening, and anti subsidy actions on EVs, solar, and wind together form a coherent, rules based approach to reshoring value. We see this as structurally supportive for domestic producers of steel and building materials, which recur as beneficiaries across several of our themes.
We believe a regulation that raises the effective cost of carbon-intensive imports tilts the competitive balance toward domestic capacity. This is a slower burn than a tariff shock, but more durable, and it reinforces the investability of the physical infrastructure layer. Within Materials, we are Overweight, with Metals & Mining a preferred exposure on a constructive commodity and bearish USD backdrop.
Chemicals is another sector which could be in scope of an expanded protectionist EU policy framework. European producers have been squeezed for years by a wave of low-cost Chinese supply, much of it built on cheaper energy and state support, at the same time as Europe's own energy costs rose. The result is a sector running below normal utilisation.
At present, the scope of CABM only covers fertilizers and hydrogen, leaving the rest of the sector exposed to higher costs and could prove to be damaging for the overall Chemical sector.
If Europe applies the same rules-based toolkit it is already using elsewhere, i.e. anti-subsidy actions, carbon border charges, or anti-dumping measures on Chinese chemical imports, it would tilt the playing field back toward domestic producers. Because the sector is already trading at low valuations and low margins, even a modest improvement in the competitive balance could have an outsized effect on profits. We see Chemicals as a lower conviction but high optionality way to play the protectionism theme.
This is a pattern across a number of industries where Chinese producers have been gaining market share over the last several years.
The Carbon Border Adjustment Mechanism (CBAM) creates clear winners among upstream producers of covered materials. Steel is the standout beneficiary, as CBAM, tariffs and a rising EUA price steepen the import cost curve, enhancing domestic pricing power and supporting an earnings recovery. Cement also benefits, with decarbonizers like Heidelberg and Holcim shielded from cheaper carbon-intensive imports. More broadly, all covered industries gain pricing power as imports can no longer undercut them on carbon-intensive goods, reducing carbon-leakage risk.
That said, there are potential losers too. Autos and Capital Goods face a cost headwind, as major buyers of CBAM-covered inputs like steel and aluminium (autos alone account for 19.7% of EU finished steel demand) absorb higher COGS, though capital goods can partly offset this through hedging and pass-through to customers. Chemicals is also at risk, since only fertilizers and hydrogen are covered, leaving the rest of the sector exposed to carbon leakage and rising EUA prices.
Europe is already running anti-subsidy actions on Chinese EVs, and local content requirements for batteries are under discussion. Autos are a huge employer and a strategic industrial base, and Chinese EV makers have built a real cost and technology lead. Tariffs and local content rules buy domestic producers time to catch up. Our sector analysts expect the EU to move on two fronts. First, they anticipate the EU will implement tariffs against Chinese plug-in hybrid electric vehicles (PHEVs) which they think could materialize as early as this year. Second, they expect the EU to establish a localcontent threshold for electric vehicles in Europe (around 70%), where EVs made in Europe would need to meet that level to be eligible for incentives, which they believe is likely to arrive in late 2027.
Clean tech manufacturing is where protectionism and energy security point in the same direction, which is what makes it compelling. The Net Zero Industry Act explicitly aims to rebuild domestic clean tech capacity, and local content requirements in wind and grids are already appearing. Chinese solar in particular has undercut European producers so heavily that much of the domestic industry has closed.
The list above highlights companies that our sector analysts believe are well placed to benefit from EU’s ongoing and potential protectionist actions.
Longer dated opportunities include...6) Ageing population
Population ageing is being driven by two structural forces: lower fertility rates and rising life expectancy. In developed markets, the working age population started to contract in 2024, and Japan and the Eurozone are among the most exposed. The main macro implication is fiscal. A higher dependency ratio means fewer workers supporting more retirees, which puts pressure on public pension systems and raises healthcare and long-term care spending. The EU old age dependency ratio is projected to increase from about 34% in 2024 to close to 60% by the end of the century. This points to sustained pressure on public finances and a policy mix that increasingly focuses on entitlement reform, higher health and care budgets, and tougher tax and spending trade offs.
From a market perspective, lower trend growth and a higher share of older cohorts with accumulated savings should keep downward pressure on equilibrium interest rates over time. Productivity gains from AI may provide some offset, but in several European economies, notably Germany, Italy and Spain, demographics are likely to remain the dominant drag relative to the 2000 to 2024 period. In equities, Healthcare stands out as the clearest structural beneficiary, spanning pharmaceuticals, biotechnology, medical devices and health technology, alongside senior care services. Wealth management, retirement solutions and life and health insurance also look well placed, with additional support in pharmacy retail and selected consumer categories that cater to older cohorts.
7) Ukraine Reconstruction and Eastern European Buildout
Rebuilding Ukraine and the wider eastern European region is potentially huge, and it lands on exactly the areas we already like: materials, steel, grids, and equipment. The timing depends on how the conflict resolves, so we keep it as a longer dated idea.
RDNA5 assessment (World Bank / EU / UN) estimates the total reconstruction and recovery needs for Ukraine at roughly USD 500–525bn over a decade, a figure that has risen as the conflict has extended. Illustrative sector allocations point to housing at around USD 80bn, transport and infrastructure at around USD 75–80bn, and energy and grid at around USD 65–70bn, with the balance spread across agriculture, social, industry, health, and water/municipal buckets.
Ukraine reconstruction is one of the largest potential infrastructure opportunities in Europe, but we note it is a phased opportunity. The early phase is stabilisation: power, logistics, telecom, emergency housing, and transport repair. The second phase is reconstruction: grid rebuild, rail, roads, schools, hospitals, ports, and municipal infrastructure. The third phase is modernisation: EU-standard infrastructure, industrial zones, energy systems, and digital public services.
Appendix
Equity Strategy Key Calls and Drivers
We have consistently argued since the second half of March to use the equity weakness brought on by the Iran conflict to buy into. To be clear, the headline risk remains, with potential need to escalate in order to de-escalate, but we do not see a sustained softness, and continue to believe that both sides have an interest in coming to terms. We have in March also highlighted that Mag-7 has started to trade at its cheapest in 10 years, and that the AI-at-risk group of stocks has already crashed, becoming record cheap. While we do not necessarily expect a repeat of 2025, when the equity rally was almost exclusive to Mag-7 for most of the 2H, we believe there is more upside for Mag-7 over the next months, as earnings are more than compensating for the stocks’ rebound. We also find the EM memory trade has legs, as meaningful supply additions are not coming before the start of 2028. Stay OW EM equities. With MXWO and MXEF at fresh highs, having more than V-shaped, is the downside risk greater than the upside one from here? We think further upside is likely as investor positioning is lighter currently than pre-conflict, P/Es are lower, we remain very bullish on the broad earnings outlook, with lead indicators pointing to continued acceleration. Further, equities are not all that complacent beneath the surface – current market breadth is very narrow – we think this is a good sign this time around, as the rally to date was more driven by AI, an orthogonal trade to geopolitics, and nearly all consumer plays are still at lows. This can change, with broadening in participation in 2H. We do not expect bond yields to rise in 2H, we see big differences from the 2022 template, and do not see stagflation as the most likely outcome for 2H. Wage growth is moving lower this time around, and corporates are unlikely to exhibit sustained pricing power, with AI anxiety an overhang on sentiment in labour markets, as well. While some hikes can happen, we think the magnitude that the market is
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