FILE – CDU party leader Friedrich Merz, elected Germany’s next chancellor, is pushing for a massive … [+]
Russian President Vladimir Putin has long envisioned a return to what he perceives as the glory days of the Soviet Union. Central to this ambition is the reintegration of former Soviet republics. After Russia’s 2008 invasion of Georgia, which resulted in Moscow seizing control of 20% of that nation’s territory, Ukraine became his primary target.
The concern among Western European nations is that if Putin succeeds in Ukraine, the Baltic states (Estonia, Latvia, and Lithuania) could be next — or even Finland. Belarus is already under his influence, and Hungary, despite its NATO membership, maintains close ties with Moscow.
This westward push has deeply unsettled continental Europe, which has traditionally relied on the United States, the most powerful NATO member, to contain Russian aggression. The return of Donald Trump to the U.S. presidency and his apparent alignment with Russia’s approach towards Ukraine has further amplified these concerns. This political shift has prompted recently-elected German Chancellor Friedrich Merz to take a dramatic and unexpected turn in his views on fiscal policy.
Merz, whose reputation is of a free-market deficit hawk, has now proposed a sweeping program of rearmament and economic investment. His plan includes the creation of a €500 billion fund for infrastructure and social spending and an exemption of all defense spending exceeding 1% of GDP from the “debt brake”—a constitutional rule that limits Germany’s structural deficit (which excludes interest payments) to 0.35% of GDP.
Explaining this dramatic policy shift during a televised debate, Merz expressed his concerns about a perceived U.S.-Russia alignment. “My impression over the last few days is that Russia and America are coming together here, over the heads of Ukraine and therefore also over the heads of Europe,” he stated. According to politico.eu Merz emphasized his commitment to European autonomy by declaring that his “absolute priority will be to strengthen Europe as quickly as possible so that, step by step, we can really achieve independence from the USA.”
Beyond the geopolitical implications, Merz’s proposals could have profound economic consequences. Germany’s GDP is 50% larger than France’s and nearly double that of Italy. Yet, its rigid fiscal policies have left the country with aging infrastructure and neglected public services.
German trains are so chronically delayed that Switzerland has banned them to avoid disrupting its own timetables. Prolonged underinvestment in education and digital infrastructure has caused Germany to fall from 5th to below 20th place in international competitiveness rankings.
European ETFs had the strongest 9-week performance against U.S. large caps in their history.
If implemented, Merz’s plan could revitalized the country’s economy and present a significant opportunity for investors. The market appears to recognize this potential: the iShares MSCI Germany ETF (EWG) has outperformed the S&P 500 ETF (SPY) by 24% in the first nine weeks of the year—the strongest relative performance since the eurozone’s early days more than 25 years ago. However, since the 2008 financial crisis, German equities have lagged behind their U.S. counterparts, a decline that coincided with the adoption of the debt brake.
Germany stocks lagged their U.S. counterparts by a wide margin ever since the country self-imposed … [+]
The potential for substantial appreciation is clear, especially if Merz successfully navigates the political and legal hurdles ahead. Other European-focused ETFs, such as the iShares MSCI Eurozone ETF (EZU) and the Vanguard FTSE Europe ETF (VGK) also present attractive opportunities. Both funds have registered their strongest 9-week performance relative to U.S. equities since their respective inceptions.
For this investment thesis to materialize, however, Merz must overcome significant obstacles. His proposals require three constitutional amendments and the support of the Green Party – not an easy task, as the Greens are in no mood to please after Merz relentlessly berated them during his campaign. They also envision broader social and climate spending goals than Merz, which means that difficult compromises are ahead if both sides are to agree on any fiscal boost.
Despite these challenges, investor sentiment is quite upbeat. The growing perception that the U.S. is retreating from its traditional role as Europe’s protector has spurred Europe’s urgent drive to revive its economy and bolster its defenses. The shifting geopolitical landscape, combined with ambitious fiscal policies, could push European equities to the top of investors’ watchlists in the coming months.
Nevertheless, the outlook hinges on one critical factor: Holding Russia at bay. If U.S. foreign policy is indeed increasingly aligned with Russia’s, as Merz and other European leaders fear, and Ukraine falls, the bullish case for European stocks may quickly unravel. For now, however, Europe’s renewed commitment to economic strength and autonomy offers investors a compelling opportunity to diversify away from U.S. equities and potentially capture the long-overdue resurgence of the region.
