Investing.com -- A potential shift in Europe’s economic trajectory is taking shape as policymakers embrace fiscal stimulus and structural reforms.
Analysts at Barclays (LON:BARC) suggest that Germany’s recent fiscal initiatives, along with broader EU reforms, could mark the beginning of what they term “Europe 2.0.”
The combination of increased spending and policy shifts has the potential to restart the region’s domestic growth engine, leading to a reallocation of investment flows toward European markets.
The recent outperformance of European equities in early 2025, initially dismissed as a mere relief rally, has now gained traction amid policy-driven optimism.
Systematic investors unwound their short positions as it became apparent that the impact of tariffs might be less severe than expected.
Additional boosts came from hopes of a ceasefire in Ukraine and improved earnings per share estimates, supported by a weaker euro.
While speculative money has turned more constructive, long-term investors remain cautious given Europe’s historically weak growth backdrop. Barclays analysts note that despite recent inflows, total investments have yet to recover from the redemptions seen in late 2024.
A key development is Germany’s proposed €500 billion infrastructure fund and a revision of its debt brake limits.
Coupled with the European Central Bank’s (ECB) recent 25-basis-point rate cut, these measures signal a decisive move toward fiscal stimulus.
If broader European reforms, including supply-side policies championed by former ECB president Mario Draghi, materialize, they could set the stage for sustained economic expansion.
Such a scenario could elevate European growth above trend levels, shifting global asset allocations toward the region and potentially driving valuations beyond historical averages.
A prolonged period of low growth and cheap borrowing costs had pushed Value investing out of favor since the 2008 financial crisis.
However, Barclays suggests that fiscal-driven growth, coupled with a higher-for-longer interest rate environment, could support a revival of cyclical value stocks.
Early indications of this shift include a rally in equities with domestic exposure, particularly in Germany.
The Barclays Germany Revival Basket, which tracks companies poised to benefit from reflationary policies, continues to outperform, while trade-sensitive stocks lag behind.
A changing macroeconomic environment also influences sectoral allocation strategies. Barclays recommends reducing exposure to euro-sensitive European exporters as the U.S. economy shows signs of slowing due to policy uncertainty and weaker employment data.
Instead, they advocate increasing allocation to domestically oriented stocks, particularly in Germany, and mid-cap companies with higher sensitivity to local economic conditions.
Financials, industrials, and materials sectors in Europe stand to benefit the most from this rotation, while luxury goods, which have high exposure to U.S. consumer trends, face potential headwinds.
Tariff risks, however, remain a lingering threat. Barclays maintains an underweight stance on the European auto sector due to persistent trade uncertainties.
Currency dynamics also play a role, with the euro appreciating against the dollar as fiscal stimulus gains traction in Europe.
While Barclays’ foreign exchange strategists caution that the euro’s upside may be limited unless U.S. data deteriorates further, they acknowledge that near-term pressure on the dollar strengthens the case for a shift toward euro-denominated assets.
Despite the optimism surrounding Europe’s fiscal push, Barclays notes that the broader economic picture remains uncertain. If concerns over stagflation or recession in the U.S. intensify, European equities may not be immune to spillover effects.
However, Barclays argues that Germany’s aggressive fiscal expansion could serve as a buffer, helping sustain market sentiment even in the face of external uncertainties.
“So we stick to our tactical preference for EU equities,” analysts at Barclays said, particularly those positioned to benefit from reflationary policies.