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On February 18, the STOXX 600 closed at 628.69, a fresh all-time high, driven by a defence sector rally and rumours of a leadership change at the ECB. Banks were up 65 percent for the trailing twelve months, their best run since 1997. Goldman Sachs had just forecast 8 percent total returns for 2026. Five weeks later, the index sat at 575, down more than 8 percent from that peak, and the ECB president was on camera telling investors they were “maybe overly optimistic.” The European recovery trade, built over thirteen months on German fiscal stimulus, falling rates, and a rotation out of expensive US tech, took five weeks to come apart.
Thirteen Months of Groundwork, Gone by Mid-March
The setup heading into 2026 was the most constructive Europe had seen since the post-pandemic reopening. The STOXX 50 had gained 18 percent in 2025. The STOXX 600 rose 17 percent, its best year since 2021. Germany’s 500 billion euro infrastructure and defence fund, announced in March 2025, was beginning to filter into real activity. The ECB’s deposit rate sat at 2.00 percent after a gradual easing cycle. Manufacturing PMI turned positive in February for the first time since 2022, printing 51.9 alongside an identical services reading. Consumer confidence hovered near a one-year high. Morningstar’s chief European strategist noted in January that valuations had recovered to within 1 percent of fair value, the tightest discount in two years.
Goldman Sachs Research published its 2026 outlook on January 6, forecasting 8 percent total returns for the STOXX 600, driven by 5 percent EPS growth and continued strength in banks and tech. Sharon Bell, the firm’s senior European strategist, wrote that the team was “more inclined to a further cyclical rally” given Goldman’s above-consensus global growth forecast of 2.9 percent. European small caps, she noted, could benefit from improving domestic demand and euro appreciation. The forecast assumed EUR/USD at 1.25 in twelve months. As of this week, the pair trades near 1.15.
None of those assumptions survived February 28.
The Sell-Off Did Not Discriminate
The first week of the war, ending March 7, saw the STOXX 600 fall 3.2 percent in a single Tuesday session. Banking stocks dropped 4.3 percent. Insurance fell 3.6 percent. Utilities lost 4.4. Even the aerospace and defence index, the one sector that had been rallying on the geopolitical premium all year, closed down nearly 3 percent. Travel and leisure cratered as airspace closures across the Middle East forced thousands of flight cancellations.
By the second week, the STOXX 600 had briefly dropped 10 percent from its record, meeting the technical definition of a correction. The selling was broad. Siemens Energy fell about 6 percent in a single session. Rolls-Royce and Rheinmetall, both beneficiaries of Europe’s defence spending boom, dropped more than 5 percent each. Deutsche Bank flagged a 30 billion dollar exposure to private credit, adding a layer of credit anxiety on top of the energy shock. Nexi, Europe’s largest payments processor by transactions, sank 22 percent to a record low after outlining a three-year strategy that the market read as an admission that growth had stalled.
The banks, which had been the spine of the European rally, cracked hardest. The STOXX 600 Banks index peaked at 385.3 on February 3 and has since fallen to around 333, a decline of more than 13 percent. Year-to-date, the sector is down 7.7 percent, wiping out roughly a third of the gains accumulated in 2025’s historic run. BBVA, UniCredit, and Deutsche Bank all fell between 1.3 and 2.5 percent on March 27 alone, as rising sovereign yields compressed the very rate-spread trade that had powered bank earnings through the easing cycle.
The One Sector That Was Supposed to Be Immune Wasn’t
Defence stocks had been the consensus overweight for European portfolios since Russia’s invasion of Ukraine in 2022. European governments committed to raising military spending from 1.5 percent of GDP toward 2 percent by 2027. BAE Systems reported a record order backlog of 83.6 billion pounds in its full-year results on February 18, the same day the STOXX 600 hit its peak. Thales posted record orders of 25.3 billion euros. Rheinmetall was a retail favourite. The logic was simple: defence spending is structurally higher, and it doesn’t depend on the economic cycle.
The war proved that logic incomplete. On March 5, the STOXX Aerospace and Defence index fell 4.2 percent, its steepest single-day decline since April 2025. Rolls-Royce and Rheinmetall led the drop. The problem wasn’t demand. Order books remained full. The problem was that a war large enough to justify those order books also produced an energy shock large enough to threaten the fiscal capacity of the governments writing the cheques. When Dombrovskis told the Eurogroup on March 27 that fiscal room “is more limited than before given previous shocks and the urgent need for additional defence spending,” he was describing the bind directly: the same conflict that makes defence spending urgent also makes it harder to afford.
What Lagarde Said, and What She Meant
On March 26, ECB president Christine Lagarde told reporters that the conflict was “a real shock” and that “the markets are maybe overly optimistic.” The STOXX 600 was then down roughly 8 percent from its peak. The S&P 500 had lost only 5.4 percent over the same period. Lagarde’s comment landed as a warning that the gap could widen further.
The ECB’s March projections supported her tone. Staff revised eurozone growth for 2026 from 1.2 percent to 0.9 percent and inflation from 1.9 percent to 2.6 percent, with the cut-off date for data set at March 11, earlier than usual. The baseline assumed oil peaking at 90 dollars and gas at 50 euros per megawatt-hour in the second quarter, then declining. Both commodities were already above those levels when the projections were published, and they’ve stayed there since.
Three ECB policymakers warned publicly during the week of March 10 that eurozone inflation would likely rise and growth sag if the war expanded. Governing Council member Peter Kazimir stated that rate hikes may be closer than initially thought. Morgan Stanley projected the ECB would hold through 2026, but the bond market disagreed: it began pricing nearly two hikes by year-end, according to LPL Research. The front-end sell-off pushed two-year eurozone yields higher, which is precisely the opposite of what the European equity rally had been built on.
The Numbers That Lagarde Left Unsaid
The recovery trade rested on a sequence: the ECB eases, borrowing costs fall, consumers spend, companies invest, earnings grow, equities rise. Every link in that chain has been either broken or reversed. The ECB isn’t easing. Borrowing costs are rising as the bond market prices hikes. Consumer spending is being eroded by energy costs. Industrial output has fallen for two consecutive months and the full energy shock hasn’t landed yet. Spain’s March inflation, reported on the same day the STOXX closed lower, showed a 1 percent monthly jump in prices, the sharpest since 2022, largely driven by the war’s impact on energy. If Spain, which has been held up as a model of renewable resilience within the eurozone, is posting numbers like that, Germany and Italy will be worse.
BlackRock Investment Institute wrote on March 23 that it was dialling down tactical risk across portfolios and downgrading US equities. The reasoning applied to Europe with even more force: “Risk assets don’t reflect the macro damage that energy pricing implies.” The Institute of International Finance put it more bluntly: “The question is no longer whether Europe can grow in a stable global environment. It is whether it can sustain that growth as geopolitical shocks begin to interact with its structural weaknesses.”
British retailer Next, reporting full-year earnings on March 27, offered a ground-level view. The numbers were strong and guidance was raised. But the CEO warned that instability in the Middle East could “restrain growth” in the company’s overseas markets if the conflict persists. H&M, reporting around the same time, delivered sales figures that Citi described as “slightly weaker than anticipated.” The consumer hasn’t collapsed. But the consumer has noticed the price of petrol, the price of heating, and the absence of the rate cuts that were supposed to offset both.
A Recovery That Got Caught in Someone Else’s War
The STOXX 600 ended the week of March 27 at 575, up 1.3 percent for the week after Trump extended a pause on strikes against Iranian energy infrastructure to April 6. That bounce followed a brief period when the index had traded as low as ten percent below its record, a decline driven not by European earnings disappointments or ECB policy mistakes but by a war in the Persian Gulf that Europe didn’t start and can’t stop.
Goldman’s January forecast of 8 percent returns implied the STOXX 600 finishing 2026 around 680. To get there from 575, the index would need to rally 18 percent from here. That’s not impossible in a ceasefire scenario, but it requires every assumption that has failed since February 28 to start working again simultaneously: falling oil, falling rates, rising consumer confidence, and a central bank willing to cut. The market priced in those conditions once. It’s now pricing the opposite.
What makes this selloff different from 2022 is that the starting point was optimism, not despair. When Russia invaded Ukraine, European equities were already trading at a meaningful discount to fair value. The fall was sharp but the cushion was there. This time, Morningstar had just noted that the discount had narrowed to almost nothing. The cushion was gone before the shock arrived. Thirteen months of careful recovery, funded by real policy changes and genuine economic improvement, collided with four weeks of war. The policy changes are still real. The improvement was genuine. But the lesson from March 2026 is that European equities remain structurally exposed to energy supply shocks in a way that no amount of domestic reform has yet fixed, and perhaps cannot fix as long as the continent imports the majority of its energy from regions it does not control.
