Barclays Expects Slower Equity Returns as Higher Interest Rates Challenge Market Outlook

Barclays strategists expect the global equity market to face more restrictive financial conditions as the monetary easing cycle draws to a close, although they continue to see scope for European stocks to advance towards the end of 2026.

In a research note, strategists led by Emmanuel Cau said the equity bull market is “arguably running on tighter margins” as the prospect of renewed monetary tightening reduces support from lower interest rates.

The bank noted that economic growth remains supported by nominal growth exceeding nominal bond yields, accommodative fiscal policies and investment spending linked to artificial intelligence, infrastructure and strategic autonomy.

However, the strategists warned that a higher cost of capital could reduce future equity returns and moderate economic growth. They also expect tighter financing conditions to constrain debt-funded AI investment and contribute to greater differences in performance between companies and sectors.

Higher Bond Yields Increase Competition for Equities

Barclays said rising bond yields are changing the relative attractiveness of equities compared with other asset classes.

According to the strategists, higher interest rates have made cash holdings more competitive, while declining equity risk premiums have reduced the additional return investors receive for taking equity market risk.

The bank said buying equities “is no longer a no-brainer” at current interest rate levels, increasing the importance of corporate earnings growth in supporting share prices.

Barclays forecasts European corporate earnings growth of 16% in 2026, followed by a further 10% increase in 2027.

The strategists said the ongoing capital expenditure cycle has supported earnings momentum, particularly in areas linked to AI development and infrastructure investment.

European Equities Could Advance Towards Year-End

Barclays said its cautious positioning ahead of September reflected expectations of greater market volatility, as rising bond yields and oil prices subsequently interrupted the summer equity rally.

Fiscal concerns also returned to focus, particularly in France, adding to the factors influencing European market performance.

Despite these developments, the bank sees a limited opportunity for European equities to move higher during the final quarter of 2026.

The strategists cited reduced investor positioning and historically supportive fourth-quarter seasonal trends as factors that could contribute to market performance.

They also noted that equity valuations and market breadth have already adjusted to higher interest rates, elevated energy prices and fiscal constraints.

According to Barclays, markets currently anticipate between three and four interest rate increases from major central banks over the next year.

Meanwhile, improvements in crude oil flows have helped limit increases in Brent prices, although a definitive easing of tensions between the United States and Iran has not materialised.

The bank considers fiscal risks in France “manageable” and said current conditions differ from those experienced during the European sovereign debt crisis in 2011.

Earnings Outlook and Regional Investment Positioning

Barclays expects third-quarter corporate earnings to provide further information on the sustainability of European equity valuations.

The strategists anticipate that earnings growth will moderate from second-quarter levels but remain in double digits.

They noted that price-to-earnings multiples have declined towards their long-term averages, changing the valuation backdrop ahead of the reporting season.

Although enthusiasm surrounding AI-related investments has moderated, Barclays said underlying growth associated with the technology remains intact.

The bank maintains a market-weight position on European equities relative to the United States, while favouring peripheral European markets and Germany over France.

Japan remains Barclays’ principal regional overweight allocation.

At the sector level, the bank favours companies benefiting from capital expenditure and maintains a preference for banks. It has also selectively increased exposure to telecommunications companies, which generally exhibit lower market sensitivity.

Barclays remains cautious on consumer, real estate and materials stocks, citing their exposure to changes in interest rates and energy prices.

The strategists’ outlook combines expectations for continued corporate earnings growth with a more restrictive interest rate environment, which they believe will make company and sector selection increasingly important.

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