European equities are quietly reshaping the prevailing market narrative. A recent Goldman Sachs research report highlights that many common assumptions about European stocks are being systematically disproven by data, from earnings growth and capital returns to fund inflows. The actual performance of European markets is far stronger than widely perceived, and as questions arise over the return on AI capital expenditure, Europe's market structure of "not chasing AI and prioritizing cash flow" is emerging as a distinct advantage.
In its August 11 report, Goldman Sachs raised its 2026 full-year earnings per share (EPS) growth forecast for the STOXX Europe 600 index from 10% to 15%, citing a 14% year-on-year EPS increase in the first half, the strongest in three years. Meanwhile, since the start of 2025, despite tariff shocks and energy supply crises, the total return of the STOXX Europe 600 has surpassed that of the S&P 500. European banking stocks have significantly outperformed the US "Magnificent Seven" in cumulative gains since 2022.
On the capital flow front, European equities are experiencing their strongest net inflows in a decade (excluding 2021), primarily driven by foreign investors. Goldman attributes this trend to a global push by investors to diversify away from concentrated risks in the US dollar and US equities. More critically, as scrutiny intensifies over the returns and financing costs of AI capital expenditure by hyperscalers, Europe's role as a "cash-generating rather than cash-consuming" market is highlighting its relative advantages.
Earnings Growth: Strongest in Three Years, Full-Year Forecast Raised
The long-held market view that "Europe has no growth" is starkly contradicted by the latest earnings season data. Goldman's data shows that the STOXX 600's first-half EPS grew 14% year-on-year, the highest in nearly three years, achieved despite headwinds from energy supply disruptions.
Even excluding the commodities sector, EPS growth is around 7%, and the median earnings growth for STOXX 600 constituents is also about 7%, indicating a broad-based earnings recovery not solely driven by commodity prices. Forecasts for 2026 and 2027 earnings have both been revised upward. Goldman describes this cycle as a "post-modern cycle" characterized by high interest rates, high inflation, and accelerated investment in infrastructure and energy security, an environment naturally favoring Europe's many "high asset, low obsolescence" (HALO) companies. These firms benefit from related capital expenditure while maintaining strong resistance to AI disruption.
Profitability: ROE Steadily Improving, Banks as Key Contributors
"Europe has low profitability" is another label Goldman challenges. The report acknowledges that European return on equity (ROE) is lower than in the US, but emphasizes that US ROE is at an exceptionally high level, and European ROE has significantly improved in recent years.
The financial sector is the primary driver. Between 2008 and 2021, low interest rates and the pressure to rebuild capital post-financial crisis weighed heavily on European banks, dragging down overall ROE. Both of these factors have now reversed. Additionally, European equities have high exposure to themes like defense spending, infrastructure, electrification, and data centers, further supporting profitability improvements.
Relative Performance: European Banks Outperform "Magnificent Seven," Once Again Beating S&P 500
The impression that "European stocks always underperform" is difficult to sustain given recent data. Goldman notes that post-pandemic, European equity performance is far more complex than the narrative suggests.
Data shows that since 2022, the cumulative total return of European bank stocks (SX7P) has significantly outpaced the US Magnificent Seven. Year-to-date in 2026, the median STOXX 600 constituent has posted double-digit gains, while the S&P 500 (excluding tech stocks) has performed relatively poorly. Goldman attributes Europe's outperformance to factors including the dampening effect of high US valuations, the impact of high interest rates on long-duration US tech stocks (which also benefits European banks), skepticism over ROI amid sharply rising hyperscaler capital expenditure, and a reduced risk premium following Germany's significant fiscal expansion. However, Goldman also warns that upcoming elections in France, Italy, and Spain in 2027 could exert greater political risk on European markets.
Energy Prices: A Boon for Stocks, Not a Bust
Goldman believes that rising energy prices are a drag on the European economy but show a positive correlation with European equity EPS, highlighting another key divergence between the economy and the stock market.
The reason lies in the European index's heavy weighting in energy and basic resources sectors. Utilities, chemicals, and financials can also pass on costs through contracts, benefiting from high inflation and interest rates. For sectors like telecom, media, and healthcare, the impact of energy prices is minimal. The only clearly affected sector is consumer discretionary. However, if energy prices remain persistently high and begin to dampen demand, companies' ability to pass on costs will be tested. Historical experience from 2022-2023 shows that after initial EPS upgrades, downgrades occurred as growth slowed and margins compressed.
Capital Inflows: Strongest in a Decade, Led by Foreign Investors
The claim that "nobody is buying Europe" is also inconsistent with reality. Goldman data shows that European equities are currently experiencing their strongest net inflows in a decade (excluding 2021), almost entirely driven by foreign investors. The primary motivation is diversifying away from concentrated exposure to US markets and the dollar, as well as avoiding high US valuations and portfolio concentration risk.
Corporate sectors are also becoming significant buyers of European equities. Share buybacks in bank and energy sectors are expanding, and M&A activity is notably accelerating, with both domestic and international buyers actively participating. This supports Goldman's European M&A candidate basket and small- and mid-cap stocks. Goldman points out that a key difference between Europe and the US is the absence of sustained retail investor inflows. While total inflows in the US and Asia far exceed Europe, backed by strong retail buying, this is a long-term missing element in European markets.
Valuation Discount: Partly Justified, but Exceeding Fundamentals
Goldman acknowledges a valuation discount for European stocks relative to the US, but believes the discount exceeds what fundamentals can explain. Data shows that within the same sales growth brackets, US companies are valued higher than their European counterparts (except in the lowest growth bracket). European dividend yields are also higher than corresponding US sectors in every industry.
Goldman sees some justification for the discount, noting that European policymakers have historically favored more regulation and taxation, and corporate earnings sustainability is weaker than in the US. However, the discount is now beyond reasonable levels. The UK's FTSE 350 is even more deeply discounted, and Goldman believes the rationale for revaluation in the UK market is stronger, a view supported by foreign M&A interest in UK assets.
AI Lag: A Short-Term Weakness, Potentially a Medium-Term Buffer
Europe is indeed lagging in AI. Data center construction is behind schedule, investment in frontier models is insufficient, and long-term productivity gains are at risk. Goldman's European utilities team believes that the energy investment needed to support AI infrastructure will create a profit super-cycle for the sector.
However, Goldman also notes that historically, in each technology wave, early movers often overinvest, and the ultimate beneficiaries are those who leverage the initial investments. More critically, the AI capital expenditure of hyperscalers can no longer be fully covered by free cash flow. The US market is seeing increasing debt and equity issuance to fund these expenditures, while Europe faces no similar financing pressure, with modest equity issuance increases and still substantial buyback volumes.
In terms of free cash flow yield, European equities offer a higher yield than bonds and are clearly superior to the US market. Goldman also cites the "DeepSeek moment" as evidence: when Nvidia fell 27% in a single day, the Magnificent Seven dropped 16%, and the S&P 500 fell 8%, European equities achieved positive returns, providing an effective hedge for investors, thanks to their value tilt and lower tech concentration.
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