By Samuel Indyk
LONDON, Aug 26 (Reuters) - European shares are expected to post only modest gains by the end of the year, a Reuters poll found, as geopolitical risks temper optimism from strong corporate earnings.
The pan-European STOXX 600 index is forecast to end 2026 at 670 points, up about 2% from current levels, according to the median estimate in an August 12 to 26 poll.
That would mark a record high for the benchmark and lift its gain for the year to more than 13%, following an almost 17% rise
in 2025.
EARNINGS DRIVER
European companies delivered robust second-quarter results, with earnings rising 24.1% from a year earlier, according to LSEG I/B/E/S data, the strongest quarterly growth since the third quarter of 2022.
Excluding the post-pandemic recovery period, the second quarter recorded the fastest earnings growth in more than a decade.
"From a bottom-up perspective, earnings have been more resilient than the macro narrative suggests," said Duncan Toms, multi-asset strategist at HSBC, who expects European stocks to tactically outperform in the coming months.
"We expect earnings strength to remain, with this persisting into 2027."
While earnings and profit expectations have improved, share prices have also climbed, pushing up valuations.
"European equities have been a key beneficiary of the 'broadening trade' in past months, supported by improving economic surprises and earnings revisions," said David Groman, global equity strategist at Citi.
"We remain neutral on European equities in our global equity allocation, as geopolitical risks remain and valuations are no longer particularly cheap."
At about 14.6 times forward 12-month earnings, the STOXX 600 trades at a 26% discount to U.S. equities, much narrower than the record 41% gap in November 2024. The shift reflects growing investor confidence in Europe's outlook and a greater willingness to pay higher multiples as earnings have improved.
CAUTION WARRANTED
Despite expectations that European stocks will edge to fresh highs, investors face several risks, including tighter European Central Bank policy and the threat of further energy supply disruptions linked to conflicts in the Middle East and Ukraine.
Money markets expect the ECB to raise its deposit rate to 2.5% next month, and assign more than a 25% chance of rates reaching 3.0% by mid-2027 as policymakers seek to prevent inflation pressures from becoming entrenched.
A major source of inflation has been the Iran war, which has disrupted energy supplies and driven up prices for crude oil, natural gas and refined products.
The benchmark Dutch front-month gas contract at the TTF hub rose this week to its highest level since the Iran-war-driven spike in March, raising concerns about higher household energy bills, increased manufacturing costs and stronger inflation expectations.
"Inflation is still a concern, and interest rates are likely to rise further," said Michael Field, chief equity strategist at Morningstar.
"We still see areas of value within European markets, particularly in sectors like healthcare, consumer discretionary and consumer staples. But on the whole, it's hard to be bullish."
Investors are also watching the euro, which has strengthened amid concerns that recent U.S. Treasury efforts to contain long-term bond yields could weaken the dollar.
A stronger euro is typically a headwind for European companies that generate a large share of their revenue outside the euro zone.
"Caution is warranted," said Marco Vailati, head of research and investments at Cassa Lombarda.
"Financial conditions could become an additional headwind, as could a stronger euro."
(Other stories from the Reuters Q3 global stock markets poll package)
(Reporting by Samuel Indyk, Danilo Masoni, Sophie Kiderlin and Ozan Ergenay. Additional polling by Sarupya Ganguly, Mumal Rathore and Rhea Rose Abraham. Editing by Mark Potter)
