A more independent Europe is taking shape, and investors are recognizing opportunities in a long-ignored region that extend beyond merely acquiring defense stocks.
While significant German spending on defense and infrastructure will take time to manifest, many investors are adopting a long-term perspective. Mark Dowding, CIO at RBC's BlueBay fixed income team, noted the shift from "Make America Great Again" to "Make Europe Great Again" trades, as the former loses its appeal.
Brussels' plan to mobilize up to 800 billion euros for rearmament, coupled with German fiscal expansion, indicates that defense stocks remain a promising area for investment, despite their recent surge following Russia's invasion of Ukraine in 2022. European aerospace and defense stocks have risen by 33% this year, and their valuation multiples have surpassed those of U.S. counterparts, reaching levels typically associated with luxury or high-tech sectors.
The tank manufacturer Rheinmetall briefly traded at 44 times its expected earnings, surpassing Ferrari in market value this month, demonstrating investors' willingness to pay a premium for exposure to this long-term trend. Projected average yearly profit growth for defense companies until 2028 ranges from 8% for BAE to 32% for Rheinmetall, according to Citi.
Despite the European Union's intent to purchase more European-made arms, challenges remain. Since 2022, 78% of EU procurement has gone outside the bloc, with 63% directed to the U.S., as reported by European Commission data.
Vontobel fund manager Markus Hansen suggests that investors should concentrate on sectors where there is real and urgent demand, including the replenishment of ammunition stockpiles and infantry-related equipment. Additionally, defense supply chain firms and sectors like communications could reap benefits from this focus. Eutelsat, for instance, has experienced a surge in interest, driven by the possibility of providing internet access to Ukraine.
"Apart from weaponry, defense encompasses logistics, data, communication, and personnel. It's a comprehensive value chain where suppliers play a crucial role," remarked Evli portfolio manager Tomas Hildebrandt. Companies like truckmaker Scania, a unit of Traton, machinery manufacturer Atlas Copco, and construction firms may also see positive impacts.
As joint EU bonds or increased German debt emerge, a broader pool of triple-A rated bonds is anticipated to support the euro's reserve currency status. Germany's historic infrastructure and defense spending could lead to over 800 billion euros in additional debt. Moreover, the EU plans to jointly borrow to back loans to member states, a move that was not anticipated by even its proponents just months ago.
This borrowing program, known as SAFE, is expected to augment the EU's current 650 billion euro debt load, signaling that the bloc may become a more permanent borrower, as investors have long hoped, stepping up to meet challenges similar to those faced during the COVID-19 recovery.
However, these loans constitute only a small fraction of the overall 800 billion euro plan, with the remainder relying on national governments. With the fiscal boost enhancing the outlook, European banks have seen significant gains, rising by 26% year-to-date, marking the best quarter since 2020.
Estimates suggest that Germany's economy should expand by approximately 1.4% in 2026 and 2027 after nearly four years of stagnation. A recent Bank of America fund manager survey indicated that banks and insurance represent the largest sector overweights in Europe, followed by industrials.
"We're optimistic about banks, as higher growth expectations should steepen the bond yield curve, benefiting banks and spurring credit growth," commented GlobalX senior investment analyst Trevor Yates, highlighting strong interest in the DAX German stocks ETF.
Investors are also anticipating that European regulators will adopt changes in line with a U.S. deregulation push. Dowding identified European bank capital bonds as the largest overweight position in multi-asset credit funds.
Spanish and Italian equities remain significantly cheaper than those in core Europe, suggesting potential for gains. Southern European stocks are disproportionately less impacted by U.S. tariffs compared to Germany or France and have substantial exposure to banks.
"There are parallel developments: there's the push toward mid-cap investment in the MDAX and the long euro trade, alongside banking regulation and growth in European nominal GDP," noted Societe Generale multi-asset strategist Manish Kabra. "The periphery of Europe presents unique opportunities."
The ongoing push for energy independence in Europe, initiated in 2022, is expected to persist, benefiting renewable energy and domestic power firms. The European Commission has proposed measures to expedite permits for renewable energy projects, revise energy tariff structures, and increase state aid for clean industries and flexible power generation.
Additionally, 100 billion euros from Germany's planned spending increase will be directed towards climate and economic transformation. Solar energy contributed 11% to the EU's electricity mix in 2024, surpassing coal's 9.3% share, according to the think tank Ember.
European utility companies, including Iberdrola, Endesa, and Enel, have seen stock price increases of 7-16% this year.