Morgan Stanley warns European stocks face prolonged tactical risks due to escalating geopolitical tensions, urging investors to prioritize defensive sectors over cyclicals. The brokerage analyzed historical episodes since 1990 using its Geopolitical Risk (GPR) index, revealing three prolonged conflicts—Gulf War, Iraq War, and Russia’s Ukraine invasion—where uncertainty lasted over 14 weeks. During these periods, European equities corrected 24% on average over 26 weeks, with cyclicals underperforming defensives by 17% as oil prices surged 38%.

The current market rotation mirrors past trends: since mid-February, cyclicals lagged defensives by 6 percentage points. Energy, Defence, and Tech Hardware were the sole sectors in positive territory on March 2, while Airlines, Autos, and Banks faced headwinds. Oil-linked sectors outperformed peers by 12% since December, though below 2022 peaks, with Energy and Metals & Mining showing strongest oil correlations (72, 69, and 68 daily correlations in March 2022). Conversely, Banks and Luxury exhibited weakest ties to commodities.

European gas prices, particularly TTF, spiked sharply in early 2026, mirroring oil sensitivities. Energy and Defence showed positive gas price correlations, while Banks and Autos faced negative ties. Morgan Stanley notes historical precedents like the 2003 Iraq War and 2022 Ukraine invasion, where markets initially sold off but recovered unevenly. The bank cautions that lingering uncertainty may delay cyclical recovery, leaving room for further relative downside.

Defensive stocks—including Utilities, Healthcare, and Consumer Staples—emerged as safer havens amid volatility. The analysis underscores oil’s enduring role in shaping equity performance, with geopolitical risks amplifying sector divergences. Investors are advised to reassess exposure as tactical risks evolve.