Goldman Sachs warns that the risk of stagflation has returned to the forefront for European equities after the Middle East conflict pushed energy prices higher and forced the bank to revise down growth expectations across the region.
The investment bank's commodities unit increased its energy price projections, now expecting Brent crude to reach $80 per barrel in the fourth quarter of 2026, up from a pre-conflict forecast of $60. At the same time, TTF gas is now forecast at 40 per megawatt-hour, higher than the prior 30 view.
Those commodity revisions have been paired with weaker macro assumptions. Goldman's economists trimmed their Euro area GDP growth forecast to 0.7% year-on-year for the fourth quarter, down from 1.4% in the pre-war outlook. They also raised their headline inflation projection to 3.2% by the second quarter, compared with a previous estimate of 2%.
Central banks have reacted to the changing inflation and growth backdrop with more hawkish pricing. The European Central Bank is now priced by markets for three rate hikes this year, versus a flat path that had been expected before the conflict.
Goldman stopped short of declaring stagflation its base case but cautioned that "the balance of risks has worsened and the probability of a stagflationary outcome has increased." The strategists highlighted the non-linear nature of macro sensitivities, warning that downside risks become materially larger if disruptions to the Strait of Hormuz persist.
Historically, stagflationary episodes have been unfavourable for equities. Goldmans data indicate that the median real quarterly return on the STOXX 600 drops to roughly -1% during stagflationary periods, compared with a typical +3% return outside such episodes. The bank's strategists, led by Guillaume Jaisson, said stagflation puts a twofold strain on equity markets by "(1) compressing fundamentals via margin pressure and (2) compressing valuations via higher rates and a more uncertain earnings outlook."
Although some sector moves already look consistent with a stagflation playbook - notably the outperformance of Energy, Value and Defensive sectors relative to Growth and Cyclicals - Goldman argues that major equity indices still reflect a view that the shock is contained and not fully priced in.
"Sharp policy repricing has created a regime within a regime," the strategists wrote, noting that abrupt and sometimes non-linear sector rotations have emerged, making it difficult to identify persistent winners and losers.
Given this environment, Goldman maintains a defensive positioning in European equity recommendations. The bank is overweight Telecoms and Consumer Staples while underweighting Consumer Discretionary, Autos and Chemicals. It also expresses a preference for Defence and Fiscal Infrastructure as areas to favour amid heightened uncertainty.
For investors seeking to "fade" a stagflationary outcome, Goldman continues to highlight European Banks as an attractive value opportunity, pointing to resilient earnings profiles and favourable income characteristics as supportive attributes.
Note: The analysis and positioning described above reflect Goldman's current forecasts and strategic views following revisions to energy and macro assumptions in response to the recent geopolitical shock.