European Stocks May Need AI-Driven Productivity Boost to Extend Rally: Morgan Stanley

New Delhi, August 29, 2026; European stock markets could require a fresh improvement in corporate earnings and profitability to maintain their recent gains, with artificial intelligence-driven productivity emerging as a potential catalyst, according to a Morgan Stanley Wealth Management assessment.

European equities have performed strongly since a recovery in global manufacturing began in November 2025. The MSCI Europe Index has gained an advantage of 2.2 percentage points over the MSCI ACWI Index and 4.8 percentage points over the MSCI USA Index in US dollar terms during this period.

However, the valuation gap that previously made European shares relatively attractive has narrowed significantly. Morgan Stanley noted that the 12-month forward price-to-earnings discount for European equities compared with global stocks fell from 24 per cent in October 2025 to around 10 per cent by July 2026, bringing it closer to its historical norm.

The investment firm believes the next major upside for European markets could therefore come from companies successfully using AI to improve productivity and reduce operating costs.

European businesses currently carry comparatively high knowledge and labour-related expenses. Combined selling, general and administrative expenses and research and development spending among MSCI Europe companies account for slightly more than 18 per cent of revenue, around one percentage point above the global benchmark.

Morgan Stanley estimates that narrowing this cost difference could substantially reduce the existing gap in operating margins between European and global companies.

However, the report highlighted several obstacles that could slow the process, including strict labour and regulatory frameworks, limited availability of workers with advanced AI expertise, and dependence on older technology and data infrastructure.

The banking sector could also face pressure to generate further efficiency improvements. European banks have benefited significantly from the recent market rally, with return on equity reaching approximately 13 per cent. That represents an increase of about 800 basis points compared with five years ago, although the improvement has recently levelled off.

Morgan Stanley also warned that government spending may not translate directly into stronger earnings for listed companies. Much of Europe’s fiscal support is directed towards infrastructure, climate initiatives, energy transition and defence, areas that have relatively limited representation within public equity markets.

The report concluded that Europe‘s recent stock-market strength has been underpinned by the manufacturing cycle and improving earnings expectations. Sustaining the rally, however, may increasingly depend on whether businesses can turn AI investments into tangible efficiency, productivity and profit gains.