AI-Led Productivity Gains Seen as Key to Sustaining European Equity Rally
Morgan Stanley Wealth Management says European equities need AI-driven productivity gains to sustain outperformance as their valuation discount over global peers has narrowed sharply.
European equities may require a significant boost in corporate profitability, potentially driven by artificial intelligence (AI)-led productivity gains, to maintain their recent market outperformance. According to Morgan Stanley Wealth Management, the region's valuation advantage over global peers has narrowed considerably, shifting the focus to earnings growth.
Since the global manufacturing recovery began in November 2025, European stocks have outpaced global markets. The MSCI Europe Index has outperformed the MSCI ACWI Index by 2.2 percentage points and the MSCI USA Index by 4.8 percentage points in US dollar terms. However, the region's 12-month forward price-to-earnings discount to the global index has narrowed from 24 per cent in October 2025 to nearly 10 per cent by July 2026, approaching its long-term average.
The report suggests that Europe's next leg higher may depend on AI-led productivity gains, given the region's relatively high knowledge- and labour-intensive operating costs. Combined selling, general and administrative expenses and research and development costs for companies in the MSCI Europe Index are just above 18 per cent of revenue, about one percentage point higher than the MSCI ACWI Index. Closing this gap could potentially eliminate nearly half of Europe's current operating-margin gap.
However, converting this potential into actual productivity gains may be challenging. The report highlights labour-governance and regulatory requirements, a shortage of AI skills, and legacy technology and data systems as key constraints to faster AI adoption in Europe.
European banks, a major driver of the region's recent performance, may also need efficiency gains to sustain profitability. Their return on equity has risen to around 13 per cent, about 800 basis points higher than five years ago, but the improvement has recently plateaued.
The report also cautions that Europe's fiscal support may have a weaker impact on listed companies than expected, as spending is concentrated in infrastructure, climate, energy transition, and defence—sectors with relatively limited representation in public equity markets. While the recent performance was supported by a cyclical manufacturing recovery and stronger earnings revisions, the next phase will increasingly depend on whether European companies can translate AI adoption into measurable productivity and profitability improvements.