Twenty-five percent of my equity allocation is in European stocks. When I mention this to American investors, they look at me like I said I'm investing in carrier pigeons. "Europe? The slow growth, over-regulated, demographically challenged continent? Why?"
Because it's cheap. And in my experience, cheap is the most reliable predictor of future returns.
The Valuation Gap Is Absurd
The DAX trades at approximately 17x earnings. The S&P 500 trades at 21.4x. That's a 32% discount for the German index — and the gap is even wider for individual sectors.
The Euro Stoxx 50 fell to 5,882 points this week but is still up nearly 15% year-over-year. The pan-European Stoxx 600 has been choppy — down 0.9% on Monday — but the trend is unmistakably higher. Over the past month alone, European equities have climbed 5.38%.
Why the discount? The market cites three reasons: slower GDP growth, geopolitical risk (Strait of Hormuz, Middle East), and energy dependence. All valid. But here's the thing — these risks are already priced in at 17x earnings. The question is whether they're worth a 32% discount to the US. I say no.
German officials just cut their 2026 GDP forecast to 0.5%. Terrible, right? But German equities aren't the German economy. The DAX 40 companies generate 80% of their revenue outside Germany. Siemens, SAP, BASF, Allianz — these are global businesses listed on a European exchange. The "slow growth" narrative punishes them unfairly.
European Banks: Finally the Right Trade
I've been watching European banks for years, waiting for the setup. I think we're in it.
European banks are trading at 6-7x earnings. American banks trade at 12-14x. The discount was justified five years ago when European banks had negative net interest margins and balance sheets full of bad debt. That's no longer true.
The ECB's rate hiking cycle did what decades of regulation couldn't — it made European banks profitable again. Net interest income is at multi-year highs. Capital ratios are strong. Dividend payouts are increasing. And the stocks are still priced as if it's 2016.
BNP Paribas (BNP.PA) is my top pick in the space. France's largest bank, diversified across retail, corporate, and investment banking, and trading at roughly 7x earnings. BNP has forecast organic sales growth of 6% for 2026. The dividend yield is north of 5%. This is a compounding machine at a bargain price.
ING Group (INGA.AS) is another name I own. Simpler business model, strong digital banking platform, and one of the highest ROEs in European banking. Trading at ~6x earnings with a 6%+ dividend yield.
The risk? If the Strait of Hormuz escalation pushes oil to $120+ and reignites European inflation, the ECB might have to tighten again, which would slow lending. That's the tail risk I'm monitoring. But at 6-7x earnings, a lot of bad news is already baked in.
Defense: The Secular Boom Nobody Expected
European defense stocks have been the single best trade in EU equities for two years, and I think they have further to run.
The numbers are staggering. In 2025, Rheinmetall rose 152%, Leonardo 93%, Thales 69%. European defense budgets are projected to grow 6.8% annually from 2024 to 2035 — outpacing the US (1.7%), Russia (3.2%), and China (3.1%). Brussels just committed 131 billion euros to defense procurement.
Rheinmetall (RHM.DE) is the leader. Revenue is projected to grow 40-45% in 2026 to 14-14.5 billion euros. They make ammunition, armored vehicles, and defense electronics — all in massive demand. The stock has been on a tear, but the growth rate justifies it. I've held since 2024 and I'm not selling.
Leonardo (LDO.MI) is my second defense pick. The Italian company has disclosed a mid-term plan targeting doubled profits by 2030. Their "Michelangelo Dome" — an air defense system similar to Israel's Iron Dome — could be a game-changer for European defense autonomy. The stock jumped 9% on the announcement.
BAE Systems (BA.L) rounds out my defense trio. The largest European defense company by revenue, with a portfolio spanning nuclear submarines to the Eurofighter Typhoon. Less volatile than Rheinmetall, more of a steady compounder.
The structural driver here isn't just Ukraine. It's the dawning realization across European capitals that they can't rely on the US for defense anymore. That political shift — from dependence to autonomy — will drive procurement spending for a decade. This isn't a trade; it's a secular investment theme.
Luxury: Bruised but Not Broken
The luxury sector has had a rough start to 2026. LVMH and Hermes shares have fallen 10-20% since the Iran conflict escalated in February. Deutsche Bank cut LVMH's price target by 14% to 620 euros.
I'm watching but not yet buying. Here's why.
LVMH (MC.PA) is the gold standard of luxury conglomerates — Louis Vuitton, Dior, Hennessy, Bulgari. The brand portfolio is unmatched. But the current environment is challenging: Chinese tourism is down (Middle East tensions diverting travel), the strong dollar hurts European luxury pricing in the US, and the wealth effect from stock markets is becoming less of a tailwind.
Bain and Altagamma project 3-5% growth for personal luxury goods in 2026. That's decent, not spectacular. At 22-24x earnings, LVMH needs to deliver above that range to justify the multiple.
Hermes (RMS.PA) is a different beast. Their limited production strategy creates artificial scarcity that maintains pricing power in any environment. Hermes has historically held up better than peers in downturns. But the stock trades at a significant premium — north of 40x earnings — which limits the margin of safety.
My plan: if the Strait of Hormuz situation resolves or de-escalates, luxury stocks will snap back 15-20% quickly. Deutsche Bank called this a "sharp reversal" scenario. I have limit orders set 10% below current prices on both LVMH and Hermes. If they fill, great. If not, there are cheaper sectors to own.
The Sectors I'm Avoiding
European tech. SAP is fine, but the European tech ecosystem can't compete with the US on AI infrastructure. The hyperscaler capex boom is an American story.
European auto. Volkswagen, BMW, Mercedes — all facing margin pressure from Chinese EV competition and weakening demand. The valuations look cheap (5-7x earnings) but could be value traps. I'm staying away.
European utilities. Energy policy uncertainty, regulatory risk, and the Strait of Hormuz situation creating input cost volatility. Not worth the headache when you can own US utilities with cleaner exposure to the AI power theme.
My EU Portfolio
Here's what I own in Europe, roughly 25% of total equities:
- BNP Paribas — 5% position, core banking exposure
- ING Group — 3% position, digital banking + high yield
- Rheinmetall — 4% position, defense leader
- Leonardo — 3% position, defense + air defense systems
- BAE Systems — 3% position, steady defense compounder
- Siemens (SIE.DE) — 3% position, industrial automation + AI at the edge
- SAP (SAP.DE) — 2% position, enterprise software, cloud transition
- Cash earmarked for luxury entry — 2%
Total EU weight: approximately 25% of equities. This is the most I've been allocated to Europe in five years. The valuation gap, the defense tailwind, and the banking recovery create a trifecta that I haven't seen before.
The Bottom Line
American investors have a home bias that costs them returns. Europe isn't sexy. The headlines are about war, energy crises, and slow growth. That's exactly why it's cheap.
I've spent a decade buying assets that nobody wants and selling them when everyone does. European equities in 2026 fit that pattern perfectly. The DAX at 17x earnings, banks at 6-7x, defense companies growing revenue 40%+ — these are the numbers that make contrarian investing worth the discomfort.
Will Europe outperform the US over the next 12 months? I have no idea. But I don't need it to outperform. I just need it to close part of a 32% valuation gap. Even a partial rerating would deliver 15-20% returns from here.
And that math is good enough for me.