Europe’s Fiscal Expansion Strengthens Investment Outlook

German fiscal stimulus and EU defense spending plans drive profit growth expectations for Eurozone equities trading at a significant discount to global markets.

Key Takeaways

• UBS upgrades Eurozone equities to “Attractive” with a 2026 target of 590 for the STOXX Europe 600, representing a 7% gain, following a pullback that creates an entry point amid improving fundamentals.
• Germany’s EUR 1 trillion fiscal package and EU defense spending plans are expected to boost industrial, technology, and defense sectors, with anticipated profit growth of 7% in 2026 and 18% in 2027 after three years of stagnation.
• Eurozone stocks trade at a 22% discount to global markets despite a forward P/E of 14.8 times, while European equities have outperformed U.S. stocks with the Stoxx 600 climbing over 7% year-to-date versus 1.9% for the S&P 500.

Introduction

For more than a decade, European equities have occupied an uncomfortable place in global portfolios: structurally cheap, chronically overlooked, and burdened by a narrative of managed decline. The continent’s economic model appeared exhausted, its growth anemic, its technological ambitions eclipsed by American dynamism and Asian scale. Investors seeking exposure to artificial intelligence, cloud computing, or the next wave of productivity gains looked elsewhere. Europe, it seemed, had resigned itself to being a museum of past industrial glory rather than a laboratory for future prosperity.

That assessment is now being tested. A confluence of fiscal, geopolitical, and structural shifts is altering the investment landscape in ways that demand serious reconsideration. Germany has abandoned four decades of budgetary orthodoxy. The European Union is mobilizing defense spending on a scale not seen since the Cold War. Manufacturing sentiment is stabilizing, corporate earnings are turning positive, and valuations remain materially below global benchmarks despite improving fundamentals. The question is no longer whether Europe can grow, but whether the policy infrastructure being built today can sustain a durable recovery.

UBS Global Wealth Management captured this inflection point in late November when it upgraded Eurozone equities to “Attractive” in its Year Ahead 2026 outlook. The firm set a target of 590 for the STOXX Europe 600, implying a 7% gain from current levels. That forecast rests on two pillars: rising corporate profitability and a valuation discount that has widened to its largest margin in a decade. The upgrade is not a bet on speculative momentum. It is a recognition that policy is finally aligning with economic reality, and that the structural underinvestment plaguing the region for years is being addressed with fiscal tools that were once politically unthinkable.

The German Reversal

At the center of this transformation is Germany, whose embrace of fiscal expansion represents a profound ideological shift. In June, the Bundestag approved an immediate investment program exceeding €115 billion, the largest single-year outlay in the country’s postwar history. The package includes €81.8 billion in net borrowing for 2025, with funds directed toward infrastructure modernization, business tax relief, energy subsidies, and defense procurement. An additional €1 billion annually from 2026 will be allocated to labor market improvements, while a multi-year fiscal framework through 2029 establishes parameters for controlled spending growth.

This is not austerity disguised as stimulus. It is a deliberate attempt to reverse years of underinvestment in physical and digital infrastructure, guided by European Commission benchmarks on public capital formation. Germany’s finance ministry estimates the program will lift GDP growth by 0.5% to 0.8% annually through 2027. That may sound modest, but in an economy where expansion has barely exceeded population growth for much of the past decade, the implications are material. The program signals that Berlin has accepted the diagnosis laid out in Mario Draghi’s competitiveness report: Europe’s productivity problem cannot be solved through incremental adjustments. It requires scale, commitment, and a willingness to breach the fiscal taboos that defined the eurozone’s last decade.

The timing is critical. Europe is navigating a world where supply chains are fragmenting, energy security is paramount, and defense self-reliance is no longer optional. Germany’s fiscal expansion is not occurring in isolation. It is part of a broader continental mobilization that recognizes economic policy and strategic autonomy as inseparable.

Defense as Industrial Policy

The European Union’s defense spending trajectory offers a parallel narrative. The European Commission’s White Paper on Defence Readiness 2030, published in March, outlined €392 billion in defense expenditures for 2025, equivalent to 2.1% of EU GDP. All NATO members within the bloc are projected to meet the 2% threshold by year-end, a milestone that seemed distant just two years ago. Discussions are now underway to raise that target to 3.5% by 2035, with half the increase earmarked for infrastructure resilience and dual-use technology.

The June Defence Readiness Omnibus begins to address these weaknesses. It streamlines procurement, strengthens the European Defence Fund, and channels capital through the EU Defence Innovation Scheme, which distributed €1.5 billion to small and medium enterprises in 2025 for dual-use technologies. The focus is on building integrated supply chains, reducing duplication, and fostering innovation that serves both civilian and military applications.

The economic spillovers are already visible. Rheinmetall launched an updated Lynx infantry vehicle in April, securing €2.7 billion in EU orders under defence fund protocols. Its hybrid propulsion systems, developed in 2024, align with the bloc’s green defense mandates. The IRIS² satellite constellation reached initial operations in October, with €10 billion committed through 2027 to develop secure communications infrastructure. Thales and Airbus are primary beneficiaries. These are not symbolic projects. They represent the early stages of a defense industrial base that is being rebuilt with deliberate attention to technological sovereignty and supply chain resilience.

Sectoral Implications

The investment case extends beyond defense contractors. Industrials, technology firms, and utilities are positioned to benefit from the policy tailwinds now in motion. UBS projects corporate earnings growth of 7% in 2026 and 18% in 2027, following three years of stagnation. Manufacturing purchasing managers’ indices are climbing above 50, signaling expansion, while artificial intelligence adoption is beginning to show up in productivity metrics. The OECD estimates that digital and automation investments could add 0.3 percentage points to annual productivity growth, narrowing the gap with the United States.

Utilities are a particular area of focus. E.ON’s €3 billion grid modernization project, announced in September and supported by German fiscal measures, reflects the intersection of energy transition and infrastructure renewal. Renewable energy integration, grid stability, and electrification of transport and industry are creating demand that transcends cyclical economic patterns. SAP’s AI platform upgrades in July, which incorporate defense-related integrations through the European Defence Fund, illustrate how technology development is increasingly blurring the line between commercial and strategic applications.

Christine Lagarde addressed these themes at the Frankfurt European Banking Congress in late November, noting the uptick in corporate digital investments despite persistent innovation challenges. She emphasized the need for digital identity frameworks, cloud interoperability, and regulatory harmonization through so-called 28th regime structures that allow firms to operate across the EU under unified standards. These proposals echo Draghi’s call for governance reforms that reduce fragmentation and enable scale.

Valuation and Positioning

European equities are trading at 15.2 times forward earnings, roughly 10% above historical averages but 22% below global multiples. That discount, the widest in a decade, reflects lingering skepticism about the region’s growth potential and governance capacity. Yet it also overlooks the capital being deployed in areas that are reshaping the economic base: artificial intelligence, electrification, power infrastructure, and industrial reshoring.

UBS maintains a neutral stance on U.S. equities, citing elevated valuations and fiscal constraints, while favoring European small and mid-cap stocks, financials, and industrials linked to electrification themes. The firm advises caution on sectors with heavy China exposure and consumer staples vulnerable to trade disruptions. Goldman Sachs and Morningstar share the constructive view, though both recommend focusing on companies with predominantly domestic earnings given the uncertainty around trade policy.

The STOXX Europe 600 is up approximately 10.7% year-to-date in euro terms as of late November, slightly trailing the S&P 500 in local currency but competitive given the differing fiscal backdrops. Currency movements matter: euro strength has compressed dollar-denominated returns, a reminder that global investors must weigh exchange rate exposure alongside equity performance.

Risks and Execution

Challenges remain. A stronger euro could erode export competitiveness, particularly for manufacturers dependent on non-European demand. NATO exercises and elevated defense readiness could strain budgets if cost overruns materialize. The fiscal programs now being implemented require sustained political will and operational competence, neither of which can be taken for granted in a region where coalition governments and institutional complexity often slow decision-making.

Yet the direction is clear. Europe is moving from rhetorical commitment to tangible deployment of capital in areas that matter for long-term competitiveness. Mark Haefele, UBS chief investment officer, summarized the shift succinctly: the cyclical outlook is improving, manufacturing is stabilizing, and policy is becoming more responsive. In a world where trade fragmentation and geopolitical rivalry are defining features, Europe’s focus on fiscal expansion and defense autonomy offers a degree of stability that merits investor attention.

Institutional allocators should approach this opportunity with clear eyes. Expected capital returns of 11% plus 3% dividend yields by 2026 make the risk-reward compelling, but only if policy execution matches the ambition. Europe’s underperformance was not inevitable. It was the result of choices: fiscal paralysis, underinvestment, and a failure to act decisively. Those choices are being revisited. Whether this marks a genuine turning point or another false dawn will depend on how well the policies now in motion translate into sustained economic performance. The early evidence suggests caution is warranted, but so is engagement.