Make Europe Great Again trades are gaining traction

By Danilo Masoni, Yoruk Bahceli and Alun John

LONDON (Reuters) - A more independent, less U.S.-reliant Europe is taking shape and investors sense opportunities in a long-shunned region that go beyond just snapping up defence shares.

Yes, there is reason for caution since massive German spending on defence and infrastructure will take time to be felt. Yet many are playing the long game.

"It seems that MEGA (Make Europe Great Again) trades are now rapidly replacing MAGA trades, which have lost their appeal," said Mark Dowding, CIO at RBC's BlueBay fixed income team, referring to U.S. President Donald Trump's Make America Great Again movement.

1/ DEFENCE FIRST

Brussels' plan to mobilise up to 800 billion euros ($866 billion) for rearmament and German fiscal expansion mean defence stocks remain fertile ground for investors, even after their surge since Russia invaded Ukraine in 2022.

European aerospace and defence stocks have gained 33% this year, and valuation multiples have topped those of U.S. peers, reaching levels associated with luxury or tech.

Tankmaker Rheinmetall was briefly more expensive than Ferrari this month, trading at 44 times its expected earnings, highlighting investor willingness to pay a premium for exposure to this long-term trend.

Defence companies' expected average yearly profit growth to 2028 range from 8% for BAE to 32% for Rheinmetall, Citi estimates.

The European Union wants to buy more European arms, but it's a challenge. Since 2022, 78% of EU procurement has gone outside the bloc, with 63% to the U.S., European Commission data show.

And after a broad rally, some advise caution.

Vontobel fund manager Markus Hansen believes investors should focus on areas with real and pressing demand such as rebuilding depleted ammunition stockpiles and infantry-related equipment.

Defence supply chain firms and other sectors including communications meanwhile could benefit.

Eutelsat has surged 260% this month, driven by suggestions the Franco-British satellite operator could replace Elon Musk's Starlink in providing internet access to Ukraine.

"Apart from weaponry, defence is also about logistics, data and communication, and personnel. It's a comprehensive value chain where suppliers play an important role," Evli portfolio manager Tomas Hildebrandt said.

Truckmaker Scania, a unit of Traton, Atlas Copco, which makes machinery for infrastructure and industrial projects, and construction companies in general, are possible examples, he said.

2/ HEY BOND

Whether it's joint EU bonds or more German debt, a wider pool of triple-A rated bonds that supports the euro's reserve currency status is coming.

Germany's historic infrastructure and defence spending could add up to more than a trillion euros of additional debt.

What's more, the EU plans to jointly borrow up to 150 billion euros backing loans to member states to help increase defence spending, a move even proponents didn't anticipate just months ago.

The bonds backing the programme, dubbed SAFE, will boost the EU's roughly 650-billion-euro debt pile.

It's a sign the bloc might become a more permanent borrower as investors have long hoped, stepping up to another challenge after its vast COVID-19 recovery fund.

The loans, however, are just a small share of the total 800-billion-euro plan, leaving the rest to national governments.

3/ BANKING ON IT

European banks are popular as the fiscal boost brightens the economic outlook, and have surged 26% year-to-date in their best quarter since 2020.

Germany's economy should expand roughly 1.4% in 2026 and 2027 after almost four years of stagnation, Berenberg estimates.

A March BofA fund manager survey showed banks and insurance are the largest sector overweights in Europe, followed by industrials.

"We're positive on banks as higher growth expectations should steepen the (bond) yield curve, which would benefit banks and really spur credit growth," said GlobalX senior investment analyst Trevor Yates, noting the firm has seen strong interest in its DAX German stocks ETF.

Investors also expect European regulators will ease rules for banks given a U.S. deregulation drive.

BlueBay's Dowding said European bank capital bonds were the firm's largest overweight position in multi-asset credit funds.

4/ PERIPHERAL WINS

Spanish and Italian equities are significantly cheaper than those in core Europe, says Societe Generale multi-asset strategist Manish Kabra, leaving them poised for gains.

Southern European stocks are also proportionally less exposed to U.S. tariffs than Germany or France and have a large exposure to banks.

"There are parallel things going on. One is the German debt brake and for that (mid-cap) MDAX and long euro is your trade, the other is banking regulation, and European nominal GDP growth, both of which impact banks," Kabra said.

"That is exactly what the periphery of Europe provides."

5/ RENEWABLE

Europe's push to become more energy independent, starting in 2022, is expected to continue, with renewable energy and home-based power firms benefiting, analysts said.

The European Commission has put forward an Action Plan to speed up permits for renewable energy projects, change how energy tariffs are set, and increase state aid for clean industries and more flexible power generation.

And 100 billion euros of Germany's planned spending increase will be channelled into climate and economic transformation.

Solar generation provided 11% of the EU electricity mix in 2024, versus 9.3% in 2023, overtaking coal, think tank Ember says.

European utility firms Iberdola, Endesa and Enel have rallied 7-16% so far this year.

(Reporting by Danilo Masoni in Milan and Yoruk Bahceli, Dhara Ranasinghe and Alun John in London, additional graphics by Samuel Indyk and Gavin Maguire; Editing by Andrew Heavens)