Analysis-Return of 'Make Europe Great Again' trades hinges on German comeback

Core Viewpoint - European markets are looking for a significant boost from increased spending in Germany, the EU's largest economy, in 2026, alongside potential positive sentiment from a Ukraine peace deal [1]. Group 1: Market Performance - European shares outperformed U.S. stocks in the first half of 2025 due to increased defense spending and changes in Germany's borrowing rules, marking a "Make Europe Great Again" moment [2]. - Despite a strong start, European stocks have returned to underperforming U.S. shares as tariff fears have eased, with the euro remaining below its four-year high of nearly $1.20 [3]. - European equities experienced inflows of over $86 billion in 2025, but the pace has slowed to $23 billion in the last six months [3]. Group 2: Economic Outlook - European stocks are expected to perform well in the coming year but are likely to remain overshadowed by U.S. markets, particularly due to the latter's greater exposure to the AI boom [4]. - The future performance of the euro is closely tied to the U.S. dollar, with some banks predicting a decline in the European currency [4]. - The focus is shifting to what Europe can do to attract investment, as the push factors from the U.S. are not as strong as previously anticipated [5]. Group 3: Germany's Fiscal Policy - Germany, which contributes about a quarter of the EU's GDP, has reformed its fiscal rules to enhance infrastructure and defense spending, which could significantly impact Europe's economy [6]. - However, much of the fiscal leeway has been allocated to day-to-day spending rather than long-term infrastructure projects that would provide a more sustainable economic boost [6]. - Infrastructure spending is expected to increase in 2026, but current budgetary plans are considered less ambitious than desired, with social spending rising faster than infrastructure investment [7].