European stock markets, despite having a low weighting in technology stocks, are not short of winners in the artificial intelligence (AI) space, which is enough to offset this shortcoming. According to Zhitong Finance, Europe's version of the AI rally has driven the Stoxx 600 index to a surprisingly strong performance this year. Although the index's technology sector accounts for only 9%, far below the S&P 500's 44%, its gains have kept pace with the latter. This achievement is particularly notable given Europe's higher sensitivity to rising oil prices and slowing economic and earnings growth.
The European AI Enabler Index compiled by Citigroup has risen 46% over the past year, which, while less than the 60% gain of the US AI winner portfolio, has shown significantly lower volatility during the period. While semiconductors are a major driver, Europe's appeal extends far beyond a few direct AI leaders. Its industrial sector is highly correlated with data center demand, and the widespread application of AI technology is expected to inject new momentum into the next phase of the AI rally.
Key areas for initial AI adoption
Beata Manthey's team of strategists at Citigroup pointed out: "Europe is still in a very early stage of the AI application cycle." They believe that industries such as industrials, healthcare, IT, communication services, and finance will be the first to benefit. "So far, the impact of AI on actual GDP and labor productivity appears negligible, but it has the potential to attract massive investment to drive AI implementation in the future."
Industrial stocks account for one-fifth of the weight in the Stoxx 600 index, second only to financials. The just-concluded earnings season confirmed that Europe's large industrial companies have become significant participants in the AI rally. The performance in the power infrastructure sector has been particularly outstanding—electrical equipment manufacturer Schneider Electric SE and industrial automation supplier ABB Ltd. both reported triple-digit growth in data center demand while raising their earnings guidance. Cable manufacturer Prysmian SpA has benefited from electrification demand in Europe and the US for some time, and new winners continue to emerge. Building materials company Kingspan Plc saw its stock price surge this week after raising its outlook due to strong data center construction and merger and acquisition momentum. Even software companies often seen as AI "losers," such as SAP, Capgemini SE, and advertising group Publicis Group SA, have recently reported accelerated revenue growth linked to AI demand.
The strong gains driven by AI have made some industrial stocks expensive. Meanwhile, recent volatility in the semiconductor sector has made investors cautious about the most direct beneficiaries of capital expenditure, and the market is increasingly pricing in risks to future growth and earnings. However, given that the investment cycle is expected to peak in 2028, valuations for some stocks remain attractive. Barclays industrial analysts believe that stock selection will be key to identifying investment opportunities. After evaluating approximately 500 data center projects, the Barclays team selected Belimo Holding AG and Alfa Laval AB in the cooling systems sector, as well as Atlas Copco AB and VAT Group AG related to semiconductor demand, all rated "Overweight." Among reasonably valued electrical companies, they mentioned Schneider Electric and Legrand SA, while taking a cautious stance on power generation equipment suppliers Siemens Energy AG and Wartsila OYJ Abp, both rated "Underweight."
AI benefits broaden across industries
Analysis of earnings conference call transcripts indicates that the benefits of AI are becoming increasingly widespread. A team of strategists at Barclays, led by Magesh Kumar Chandrasekaran, stated: "The quantifiable benefits of AI are spreading across multiple industries. Notably, quantifiable cost and efficiency improvements have become a focus of discussion, with substantive commentary on realized gains increasing."
Europe may currently be in a favorable position. Corporate balance sheets are healthy, and free cash flow yields are much higher than in the US. While S&P 500 companies are busy with capital expenditure rather than share buybacks, their European counterparts hold a strong hand—higher shareholder returns, fewer share issuances, more robust financial positions, and significantly lower AI-related risks from semiconductor volatility or Chinese competition.
Sharon Bell's team of strategists at Goldman Sachs believes that while Europe is clearly lagging in the early stages of AI innovation, this is not necessarily a bad thing. Instead, Europe needs to ensure it captures the productivity improvement potential offered by AI, especially given the region's rapidly aging population. Europe has been slower in deploying data centers, and will need to significantly increase investment in energy infrastructure to support AI development in the future, which could kick off a "super cycle" for its utilities sector. They stated: "In multiple historical technology waves, first movers and innovators often overinvest, while the ultimate beneficiaries are those who can leverage the initial investment results, not those who pay for it."