UBS upgrades financials and capital goods in European sector rotation

UBS upgraded investments in the European financial and industrial sectors while removing energy and materials from its top picks this month. The firm cites improved profit revisions, appealing prices, and positive macroeconomic signals across Europe as the reasons behind its changes. Diversified financials, banks, insurance, and industrial goods all fit well within UBS's REVS framework, which scores companies based on their earnings, valuation, risk, and sector.

Factors such as government spending, infrastructure investment, and a growing industrial cycle are creating new opportunities beyond the traditional beneficiaries of artificial intelligence. Stocks that align with this trend include IG Group, ACS, Rockwool, Prysmian, and SPIE. UBS noted that European equities are performing well overall, driven by a better-than-expected earnings season and improving macroeconomic conditions, indicating that the market is no longer solely dependent on a small number of AI-driven companies or banks.

Multiple sectors are now experiencing strong earnings revisions, with consensus expectations of nearly 18% earnings per share growth for Europe this year, a sharp contrast to the lack of growth seen in the previous three years. AI continues to be a significant growth driver, with the strongest earnings upgrades continuing to come from AI-related companies.

European AI enablers, electrification, and specific renewable energy projects are among the highest-ranked themes in UBS's framework. Industrial and financial sectors are broadening their participation in the upgrade cycle. Purchasing managers' index data confirms the earnings story, with new orders indicators rising decisively above 50 in several large sectors, including banking, pharmaceuticals, and industrial businesses.

UBS remains optimistic about the pharmaceutical sector after valuations have become more attractive. Conversely, retail, food retail, UK consumer goods, and healthcare equipment and services have been moved to UBS's least-preferred category due to declining earnings momentum and poor rankings. The ongoing conflict in Iran and its impact on energy markets have not caused the steep earnings shock that many had feared, even though European gas storage levels remain relatively low.

European fiscal policies supporting defense, infrastructure, and industrial investment are growing, particularly in Germany. Despite relatively weak investor positioning compared to other major markets, passive flows and ETF allocations have started to improve after a period of decline. UBS believes stronger earnings delivery could attract additional capital into European equities during the second half of the year, potentially pushing the Stoxx 600 to its target of 690.

Current consensus single-stock target prices are also rising, aiming for 750 for the Stoxx Europe 600, indicating about a 9-month duration. UBS projects a 2026 price target of 690 for the Stoxx Europe 600, representing a 4% upside, and a 2027 target of 760, suggesting a 15% upside.