European Equities Present a Balanced Risk/Reward Profile

As the European market rallied, some investment opportunities have disappeared as sectors catch up to Morningstar’s fair-value estimates. We maintain a neutral view on European equities excluding the United Kingdom, but we see investment opportunities in certain countries and sectors.

In a recent research report, Morningstar’s multi-asset research sets out risk-and-return expectations for the coming 10 years. The report shares our asset class- and stock-level perspectives on valuation as a starting point for strategic asset allocation decisions.

For a deeper look, download the full Equity Market Review: Europe Ex-UK.

Almost two-thirds of the Europe ex-UK market is concentrated among just three countries: Germany, France, and Switzerland. Six countries represent almost 85% of the combined market capitalization when we add the Netherlands, Sweden, and Spain into consideration.

The market also skews toward a few dominant sectors. Two-thirds of the market is concentrated in industrials (28%), financial services (27%), and healthcare (12%). If we add the consumer sectors to this number, the total goes to almost 80% of the market.

Despite often grabbing headlines, sectors like communication services and utilities contribute only 4% and 2% of the market, respectively. Unlike the United States, the Europe ex-UK index has surprisingly little exposure to the telecommunications and technology sectors.

The top 10 companies in the Morningstar Europe ex-UK Index account for roughly 25% of the index’s market capitalization. However, concentration in the Europe ex-UK market is low compared to the other broad markets we evaluated. The United Kingdom showed the highest percentage of market capitalization in its top 10 holdings.

Through an asset-class valuation lens, Europe ex-UK stocks appear moderately unattractive.

We expect fundamental profitability to revert to our long-term assumptions, mainly driven by France and Germany. On the positive side, Europe ex-UK’s total payout is in line with our long-term assumptions, and we expect investors to keep receiving similar payout levels in the next decade. However, we expect net profit margins and returns on equity to contract, which impinges on forward returns.

Among the largest countries, we see this negative profitability being driven by France and Switzerland.

From a bottom-up perspective, we think the ex-UK market is trading at a modest discount to our fair value estimate. The market remains moderately attractive.

As the European market has rallied, some appealing investment opportunities have disappeared. We recommend looking to small-cap and value stocks, where valuations compare favorably to the United States.

We find that stock opportunities are dispersed across most sectors. Look to consumer cyclicals, healthcare, and technology for decent upside potential. On the other hand, the financial-services sector has had a strong performance over the last year, catching up to our valuations.

Overall, our view on the European ex-UK market is neutral.

For our full long-term capital assumptions, including 10-year expected returns by country, download the report.

The euro area economy is bouncing back after highly restrictive monetary policy held back its economic performance in 2023-24. Energy price shocks associated with the invasion of Ukraine also held back growth over this period.

The International Monetary Fund expects GDP growth to average 1.2% over 2025-29, reflecting a return to growth among euro area economies that is more reflective of their potential amid more neutral monetary conditions.

Inflationary pressure has eased considerably in the euro area, following global supply chain constraints and record-low unemployment, which drove price inflation to unprecedented levels in 2022-23. To contain surging prices, the European Central Bank deployed highly restrictive monetary conditions. The bank’s deposit facility rate set a record in September 2023.

With the ECB’s war on inflation proving successful, the central bank began easing rates in mid-2024. Interest rates in the euro area are presently at a largely neutral level.

In the medium term, the IMF expects inflation to remain in check, forecasting average inflation of 2% over the coming five years. Inflation in the euro area has averaged 2.1% over the prior 20 years, largely in alignment with the ECB’s 2% target for inflation.

Europe’s aging population presents a challenge to its long-run economic growth outlook.

The euro area’s working-age population is expected to shrink by more than 4% over the coming decade. We estimate that will amount to an approximate 0.25-percentage-point headwind to economic growth annually over the coming 10 years.

Several European countries have sought to directly address labor force declines through increased immigration. However, the political discourse surrounding the topic of migration has turned distinctly downbeat in Europe. Sour sentiment among European voters threatens to stem the future flow of migrants.

Europe’s digital technology sector pales in comparison to the United States. And China is making significant inroads in clean technology and electric vehicles. Understandably, closing the innovation gap with the US and China is the top priority identified by the European Union in a recently published report on EU competitiveness.

In short, Europe fails to commercialize its innovative ideas, with scale-up hindered by a range of issues, including:

• A lack of venture capital funding
• Too few links between European universities and startups
• Onerous taxation and business regulations
• Inflexible labor markets

Consequently, many of Europe’s high-growth companies have migrated abroad, particularly to the United States, where conditions are more conducive for scale-up.

US President Donald Trump’s recent backdown on tariffs effectively rules out the most devastating of outcomes for the EU from the US’ trade policy shift. With the United States agreeing to an across-the-board 15% tariff rate on EU goods entering the US, the economic fallout is manageable for the EU. 

Indeed, it is estimated that the US’ tariffs should cause the EU’s economy to be less than 1% smaller in 2030 than it would have otherwise been. 

Moreover, the shock posed by the trade dispute to the short-run performance of the EU is beginning to fade. Consumer confidence is beginning to rebound from the knock it took in the immediate aftermath of the trade shock in April 2025. 

Except for the United States, Europe ex-UK has outperformed other key markets over the last 10 years. The region’s cumulative performance topped emerging markets, the United Kingdom, and Asia-Pacific developed markets.

In the last 12 months, the top five performers contributed around 20% of the market return:

• Siemens Energy AG
• Rheinmetall AG
• Commerzbank AG
• Societe Generale
• Saab AB

Most of the real total return came from margin expansion over the five years ending Aug. 31, 2025.

The full multi-asset research report delves into:

• Market composition and past performance.
• Additional economic metrics, drivers, and risks.
• Stock-level valuations by size and style.
• Price/fair values by country.
• Economic Moat Ratings and Uncertainty Ratings by industry.