Valerio Baselli: Hello and welcome to Morningstar. European stocks have regained attention after years of underperformance. Valuations remain attractive, interest rates appear closer to a peak, and the debate is shifting from whether to own Europe, to how to own it.
To explore that, today I’m joined by Hywel Franklin, Head of European Equities at Mirabaud Asset Management.
Hywel, first of all, what makes 2026 a potentially different year for European equities?
Why 2026 Could Be a Breakout Year for European Stocks
Hywel Franklin: Well, Valerio, I think 2026 could really be a tremendous year for Europe. One of the key things is that we have all of the ingredients now for recovery in place - those low valuations, the investor under-allocation, the fact that monetary and fiscal support looks to be broadly in place. And you know, there’s low expectations for companies which they should be able to show some upside against. So those are some of the reasons for Europe.
Baselli: One of the most contentious questions in 2026 is whether European small caps, which have been under pressure for a long time, now offer better opportunities than the large caps that usually dominate portfolios. Where do you stand on that?
European Small Caps vs. Large Caps
Franklin: For me, there’s no real contest. I think it’s got to be small caps from here. The ultimate reality is that as people look to reallocate into Europe, sometimes, they go with the large caps first. That’s an easier trade to execute initially, but there’s more upside in the small caps, you know, better valuation support and, as the environment improves, we should see the small caps respond to that more strongly than the large caps, in our opinion.
Baselli: And which markets or sectors offer the most compelling small cap opportunities in Europe today?
Franklin: So, for us currently, we’re seeing good opportunities around a range of countries. It could be like Italy, Norway, Germany, these are all countries that we’re overweight. We think, you know, a lot of opportunities in financial and consumer. But ultimately for us it’s all about being highly active, very selective. We’re finding the absolute best opportunities in sectors which are underappreciated, under-owned, and particularly at the very small end of the market, kind of sub 2 billion.
Baselli: The valuation gap between European small caps and large caps is currently very wide. Do you think passive flows have somehow distorted valuations in favor of large caps? If so, what are the consequences?
Are Passive Investment Flows Distorting European Stock Valuations?
Franklin: Without question, in my view, passive flows have had a big driving impact on the market. Unfortunately, what it means is that, you know, there are some valuations which are being pushed ahead of reality. Now, one of the issues it creates is that, you know, some of the stocks at the larger end of the market become riskier. And, you know, one of the scenarios to think about is what happens if some of this passive flow goes into reverse. We might find in that environment that the larger companies prove to be more vulnerable, more volatile than they have been in the past. This is, again, one of the reasons why we prefer the smaller end of the market, because we think that, you know, there are less passive investors, buying without a view towards fundamentals and valuation.
Baselli: Liquidity risk is often cited as a reason to avoid small caps. What are, in your opinion, the biggest risks to a European small-cap recovery?
Franklin: I think on a long-term basis there’s not that much that I worry about. I think, you know, if anything there are things which could delay a recovery. And this would be, you know, economic shocks, or if we have a major policy error, you know, it could be if there’s a downturn, of course, that will hurt all risk assets. But ultimately, I think there are other areas of the market, as I mentioned, which look more vulnerable. We’ve talked about some of the passive flows, but we’ve also got to look at the that market concentration in the really, really hot areas of the market particularly, you know, the US, tech names, some of the AI exposed companies where if there is a real, challenge to that thesis that we, we could see a lot more downside.
3 European Small Cap Stocks to Watch
Baselli: Finally, can you list 3 European small cap stocks you particularly like at the moment?
Franklin: Sure. So, yeah, we really like, in Italy, Credito Emiliano CE. This is an Italian bank, but it’s also got an asset management business within it, which is really exciting and gaining share over time. We have Norma NOEJ, that’s a company listed in Germany. That’s in the automotive and industrial area. It’s an area where there’s a lot of skepticism in the market, but where we see a significant value, and maybe for the third, AcadeMedia ACAD, in Sweden, this is a company in the school space, you know, very good visibility. And, you know, a business which is extremely cash generative. So, those would be three companies which we particularly like within the European small cap space.
Baselli: Very interesting- thank you so much for your time, Hywel. For Morningstar, I’m Valerio Baselli. Thanks for watching.
