The Urgent Push for European Defense Autonomy

Following the Cold War, European defense spending has been insufficient and the beginning of the war in Ukraine, have exposed severe deficiencies in military infrastructure and ammunition stockpiles. With U.S. President Donald Trump stopping support for Ukraine and urging Europe to take greater responsibility for its own defense, Europe has been forced into action.

European leaders increasingly recognize that relying on Washington for security is no longer a viable long-term strategy. Calls for Europe to achieve independence from U.S. military support have grown louder, with efforts focused on increasing defense spending, strengthening military readiness, and continuing support for Ukraine, with the EU recently approving €800bn defense plan.

The EU’s massive defense investment plan is a game changer, setting the stage for unprecedented growth in the European defense sector and transforming it into one of the most compelling investment opportunities in recent years, with defense stocks soaring to record highs.

Germany’s Unprecedented Fiscal Stimulus

For decades, Germany has been enforcing strict spending limits and rejecting debt-driven stimulus. However, now, Germany is embarking on a historic fiscal expansion which would widen Germany’s deficit and revive economic growth. A €500 billion infrastructure fund and a significant boost to defense spending are set to bypass Germany’s rigid debt brake, marking a decisive break from past policies.

This decision, supported by Friedrich Merz’s administration has been a major driver of the DAX 40’s surge at the biggening of 2025. Markets have responded with enthusiasm, sending defense stocks soaring, as this is a transformative moment for German growth.

Additionally, the European Central Bank’s (ECB) expected monetary easing has been providing further support. Lower borrowing costs enhance corporate profitability and drive investment flows toward stocks, particularly those in capital-intensive industries.

The Remarkable Strength of DAX 40 Despite Current Market Turmoil

U.S. stocks stumbled in February, with the S&P 500 tumbling more than 15% YTD. The post-election rally that fuelled optimism late last year has faded and has been replaced by growing investor anxiety over risks of stagflation and slowing economic growth.

Yet, amid the turbulence in U.S. markets, certain regions have been thriving under the Trump administration’s geopolitical stance. After years of being overlooked, the German stock market has finally stepped into the spotlight.

In the first two months of 2024, German equities posted their strongest rally in decades. Despite the mid-February global stock markets plunge, the DAX 40 is still up more than 1% YTD, outperforming the S&P 500 (down almost 16% YTD), by a staggering 17%, which is the widest performance gap in over 30 years.

The DAX 40 index has emerged as one of the best performers in 2025, beating major European and global benchmarks. This outperformance defied broader economic challenges amid combination of fiscal expansion, monetary easing, and improved investor sentiment, reinforcing its position as a key player in global equity markets.

Additionally, the strong performance of the DAX 40 has been supported by the underperformance of U.S. stocks, triggered by Trump’s tariff policies, fears of potential spike in inflation and slowdown in economic growth, which have revived worries of stagflation. Investors have been moving away from big US tech stocks toward defensive, lower-valuation sectors, benefiting Europe, where stock indexes are more value-oriented.

Source: TradingView

Investors Are Flocking to German Equities

One of the most notable trends in recent months has been the reallocation of capital from U.S. equities to European markets. The uncertainty surrounding U.S. policies and stretched valuations of the S&P 500, have prompted investors to seek alternative opportunities.

Bank of America’s latest fund manager survey underscores this trend, revealing that investor positioning in German equities has changed from historically underweight levels to a more neutral level.

Valuation disparities have been one of the drivers of this rotation. Grman stocks have traded at a discount to U.S. equities for over a decade, drawing interest from global investors in search of value. The depreciation of the euro against the US dollar in early 2025, further enhanced the appeal of German stocks.

The impressive rally of the DAX 40 in the first two months of the year have been largely driven by software giant SAP, defence contractor Rheinmetall, industrial powerhouse Siemens, Siemens Energy, Deutsche Telekom, and insurance titans Allianz and Munich Re.

SAP has the largest market cap among the DAX 40 constituents and now holds a greater weighting in the index than the entire auto sector, which has been underperforming this year.

Siemens Energy has been supported by surging demand for renewable energy solutions, while Rheinmetall has climbed more than100%, buoyed by rising expectations of increased defence spending across Europe. Siemens and Deutsche Telekom have also played a crucial role in the index’s climb, reflecting broader industry trends favouring digitalization and infrastructure development.

The DAX has seen a notable change in its composition over the past decade, moving away from traditional heavy industry and pharmaceutical names, toward more financially and technologically driven firms.

Interestingly, the DAX 40 has outperformed Germany’s mid-cap and small-cap indices, which is a rare occurrence in historical context. This highlights the strength of large-cap stocks in weathering macroeconomic uncertainties and benefiting from global capital flows.

Trump’s Tariffs Push Transatlantic Ties to the Brink

Despite these tailwinds, external risks loom. President Donald Trump’s sweeping 25% tariffs on cars and light trucks not made in the U.S. announced on the 27th of March, which officially took effect on the 3rd of April, have sent shockwaves through the German automakers sector.

On “Liberation Day” the US has imposed a separate 20% reciprocal tariff on the European Union, delivering a major blow to the eurozone economy. With these new trade barriers, the short-term economic outlook is deteriorating as this poses a significant challenge to European exporters. The pressure now is on European governments to accelerate fiscal stimulus and economic reforms to sustain domestic growth.

The new tariffs announcement marks a clear deterioration in Transatlantic relations, not just in defense and security, but also in trade. Since the US elections, it has been clear that Washington’s economic strategy prioritizes domestic growth at the expense of key trading partners, echoing protectionist policies of the past. These new tariffs, combined with earlier levies on steel, aluminium, and automobiles are set to further strain the German export driven economy.

For now, the EU has not announced countermeasures, favouring negotiations over immediate retaliation. However, officials have reaffirmed that if no resolution is reached, Europe will respond with firm countermeasures to protect its economic interests.

While trade wars rarely produce winners, some suffer more than others. Despite recent positive developments such as European defense initiatives and Germany’s fiscal boost, Trump’s tariffs are darkening the DAX 40 near-term prospects. Nonetheless, we expect the index to continue to outperform its US peers in 2025.

Investors worry that retaliatory measures from the European Union could exacerbate inflationary pressures in the block, increasing the odds for another ECB rate cut next week, and also calls for more aggressive policy easing in 2025.

Investor sentiment has already deteriorated significantly. Market volatility has surged over the past two weeks and the DAX 40 plunged 21% on an intra-day basis from its all-time high, amid widespread de-risking across equity markets.

On Monday, the European Commission has offered the United States a deal to remove tariffs on all industrial goods as part of the trade negotiations. Should negotiations fail, the EU signalled that is ready to retaliate against Donald Trump’s tariffs.

In the absence of meaningful negotiation in the next few days, the European Union could respond with countermeasures to defend its interests and escalate the trade war. Such scenario would weaken corporate earnings and reduced economic activity in the block.

Despite Germany’s economy facing headwinds and recessionary pressures still evident, market participants may continue to find value in Germany’s flagship index. While further weakness cannot be ruled out in the short-term, fiscal expansion, monetary easing, and capital flows are positioning the DAX 40 to continue to outperform global peers. While trade tensions and inflation risks require careful monitoring in the near-term, the DAX 40 appears poised to outperform peers in 2025.

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