7. An EU revival: Restructuring and reform

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7. An EU revival: Restructuring and reform

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7. An EU revival: Restructuring and reform

What we said
We were cautiously optimistic on an EU revival based on three pillars:

  1. a sustained step‑up in defence spending,
  2. the energy transition shifting from regulatory burden to industrial opportunity, and
  3. innovation as the key driver of future growth.

How it has played out

Defence and security: commitments turning into cash
Defence spending has continued to rise at a sustained and rapid pace, despite additional pressure on public finances from the energy shock. Several European countries recorded defence spending growth above 20% in 2025, and this trend has extended into 2026. In the first three months of 2026, Germany spent almost 20% more on defence than in the same period of 2025, confirming that the Merz government’s multi‑year investment plan is being implemented.

The EU has also released €90bn in financing for Ukraine following the change of government in Hungary. The new Hungarian administration has pledged to align with Brussels on civil liberties and judicial independence, opening the door for EU funds – including defence‑related spending – to flow to Budapest.

In parallel, the EU is discussing accelerated accession for Ukraine, which has developed cutting‑edge capabilities in modern warfare, particularly drones. This underscores the strategic dimension of Europe’s defence push.

Energy transition: the shock as an accelerant
The energy pillar of the theme has played out more positively than expected, helped by an accelerant we did not fully anticipate: the Middle East energy shock. The effective closure of the Strait of Hormuz has sharply reduced tanker traffic, disrupted oil supply and reinforced the case for Europe to accelerate domestic clean‑energy deployment, electrification, grid upgrades and energy efficiency.

The European Commission’s AccelerateEU initiative now explicitly frames the clean‑energy transition as an economic, competitiveness and security imperative. The Commission estimates that since March 2026 the EU has incurred €24bn of additional fossil fuel spending, while 57% of EU energy consumption still comes from imported fossil fuels. Higher oil prices therefore strengthen the case for green investment that reduces import dependence and improves resilience.9

After a softer patch, Europe’s electric vehicle (EV) market is re‑accelerating. The IEA reports that European EV sales rose by more than 30% in 2025 and expects Europe to deliver the strongest growth among major EV markets in 2026.10 ACEA data show EU battery‑electric vehicles reaching a 19.7% market share in the first four months of 2026.11 The outlook is constructive, but the pace of adoption remains sensitive to policy stability, affordability, charging infrastructure and intensifying competition, particularly from Chinese manufacturers.

Innovation and Swiss competitiveness
The energy and supply‑chain disruptions of 2026 reinforce a broader principle: in an environment of elevated input‑cost volatility and macro uncertainty, innovation‑driven pricing power becomes a defining competitive advantage.

Switzerland is a clear example. It has been ranked first globally in innovation for 15 consecutive years by the World Intellectual Property Organization and first in AI researchers and developers per capita in the 2026 Stanford AI Index Report. A structurally appreciating Swiss franc forces Swiss companies to compete on deep technical differentiation rather than price, leaving them well placed in a world where innovation is the key to future growth.

Outlook for H2 2026
All three pillars of the EU revival theme remain supportive for H2 2026. Defence spending commitments are multi‑year and largely insulated from short‑term budget pressures. The energy transition retains strong policy backing through AccelerateEU, though selectivity is essential after strong performance in parts of the clean‑energy universe. In a world where innovation is central to growth, Europe – and especially Switzerland – is structurally well positioned.

Action for investors:

  • Stay invested in the green transition as a medium‑term opportunity across industrials, utilities and companies linked to electrification and energy efficiency. Focus on beneficiaries of AccelerateEU‑related spending, particularly those exposed to grid upgrades, clean power, storage and efficiency solutions.
  • Look for upside in European and Swiss small & mid‑caps, which stand to benefit disproportionately from increased defence and green‑capex activity, as well as from Europe’s innovation strengths.

9 https://energy.ec.europa.eu/strategy/accelerateeu-strengthen-eu-energy-resilience_en
10 https://www.iea.org/reports/global-ev-outlook-2026/executive-summary
11 https://www.acea.auto/pc-registrations/new-car-registrations-4-2-in-april-2026-year-todate- battery-electric-19-7-market-share/

7. An EU revival: Restructuring and reform

The EU will take further restructuring and reform steps in 2026. This is due to external threats (particularly from Russia) and pressure from the US to increase defence spending. Europe’s strength in innovation and collaboration between member states will continue to be a critical factor here.

We believe a renewed excitement for European and Swiss equities is likely. This positive view is driven by a range of potential catalysts, including: (1) More material German stimulus impact; (2) Increased defence spending; (3) Revived interest in green energy and carbon reduction spending; and (4) Levels of innovation. Furthermore, there is an improving eurozone credit impulse and lower interest rates.

German fiscal spending is a potential catalyst for improving economic activity
The EUR500bn infrastructure package and the circa EUR1trn more on defence spending over the next decade are large by historical standards. While Germany has historically underspent, we see three reasons why this time could be different: (1) Merz’s political willingness is indisputable; (2) There is no shortage in identifiable investment projects, and there are already specific plans on where the money is to be spent, from railways and bridges to contracts in the defence sector; (3) Substantial sums are being directed through federal states, which have considerable local investment needs. A fifth of the EUR500bn infrastructure fund will be spent by Länder, which will also have more flexibility for structural new borrowing.

Defence security
Global geopolitical tensions have revived the issue of the extent to which Europe can be strategically autonomous. One aspect of that could be a truly unified military and defence capability but this remains politically sensitive and may take decades to achieve. However, there is clear progress on increasing European countries’ defence spending. 23 of the 27 EU member states are in NATO and 16 of these had defence spending above 2% of GDP in 2024 (Figure 9). All members are expected to reach or exceed the 2% target in 2025 according to commitments made to NATO, with all members targeting a level of 5% by 2035. This extra spending is being tolerated, even with other pressures on government spending.

Green transition
Another key catalyst for renewed optimism in European equities is the revival of green-energy and carbon-reduction spending. Policy momentum remains supportive: the EU’s Clean Industrial Deal, introduced in early 2025, and its Affordable Energy Action Plan aim to lower energy costs, stimulate transition-related investment, and support demand for low-carbon products shifting the focus from regulation to industrial competitiveness. According to European Commission estimates, faster electrification and efficiency improvements could reduce the EU’s fossil-fuel import bill by around EUR130bn per year by 2030, and up to EUR260bn by 2040, improving resilience and lowering long-term energy dependence.

Progress is already visible, with renewables providing close to half of EU electricity in 2024, while the Carbon Border Adjustment Mechanism (CBAM), to be fully implemented in 2026, reinforces incentives for cleaner production. In our view, these developments provide a constructive medium-term backdrop for Europe as it deepens its green transition creating opportunities across industrials, utilities and companies linked to electrification and energy efficiency.

Innovation
In this knowledge-based economy we live in, intangible assets such as intellectual property – combined with inventions, patents and technological know-how – have become central sources of value creation on a country level and on a company level. One such example is Klarna, which was the first European company and the first fintech firm globally to launch a ChatGPT plugin. Klarna’s AI assistant has had over 2.3 million conversations, accounting for two-thirds of Klarna’s customer service chats, and is doing the equivalent work of 700 full-time agents while also leading to faster and more accurate errand resolutions. 13

Of course, in an era increasingly shaped by artificial intelligence, where many forms of intellectual work risk being automated or displaced, the value of uniquely human capabilities – talent, creativity and adaptive thinking – become even more critical ingredients of innovation. According to the Global Innovation Index, 16 of the 25 top-ranked innovative economies are in Europe. Switzerland exemplifies this dynamic (Figure 10). As recent INSEAD research highlights, the country continues to lead in both talent competitiveness and in innovation, ranked number 1 globally for 15 years in a row. Having one of the most skilled labour forces underpins Switzerland’s leadership across key industries, including finance, medical technology, pharmaceutical and precision manufacturing. In a world where innovation is the key to future growth, this means Europe is well placed.

Action for investors:

  • The potential upside in economic and industrial activity could be particularly beneficial to Swiss and eurozone small & mid-caps.
  • The green transition is creating opportunities across industrials, utilities, and companies linked to electrification and energy efficiency.
  • Look for opportunities in defence and industrial companies.

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