Eurozone Manufacturing's Delicate Rebound: Seizing Opportunities Amid Tariffs and Turbulence

The Eurozone's manufacturing sector is balancing on a knife's edge. After 35 months of contraction in Germany and intermittent recoveries in Spain, May's PMI data reveals a fragile yet promising shift—Spain's manufacturing sector exited contraction, while Germany's stagnation persists amid looming U.S. tariff threats. For investors, this divergence presents a tactical opportunity to pivot toward periphery markets with improving momentum while hedging against protectionism-driven risks.

Spain's Resurgence: A Buying Opportunity in Export-Oriented Equities

Spain's manufacturing PMI surged to 50.5 in May, marking its first expansion since January and outpacing Germany's stagnant 48.3 reading. This recovery is underpinned by three key factors:

1. Demand Stabilization: New orders stabilized after three years of decline, while output rose for the third straight month. Even sales volumes, though still falling, did so at the slowest pace in four months.
2. Cost Discipline: Input costs dropped for the first time since early 2024, and output prices fell to their fastest rate in eight months due to competitive pressures. This creates a margin-friendly environment for firms in sectors like automotive and machinery.
3. Sentiment Turnaround: Business confidence for the next 12 months hit a three-month high, fueled by optimism about broader Eurozone recovery and indirect benefits from improved global trade dynamics.

Investment Play: Target Spanish equities with export exposure but lower U.S. trade reliance. Consider sectors like renewable energy equipment (e.g., Iberdrola's green tech exports) or automotive components (e.g., Gestamp's global supply chains). The IBEX 35 index (^IBEX), which includes these firms, is primed for gains as Spain's PMI trends improve.

Germany's Prolonged Struggle: Caution Amid Protectionism

While Germany's manufacturing sector showed marginal improvements—output rose for the third consecutive month, and job cuts slowed—the 48.3 PMI reading underscores a 35-month contraction. The key risks here are structural:

• U.S. Tariff Threats: New U.S. tariffs on EU goods, particularly in steel and aluminum, could derail Germany's nascent rebound. These industries account for 15% of Germany's manufacturing exports, and any new duties would hit firms like ThyssenKrupp and Siemens.
• Domestic Demand Lag: While export orders from the U.S. and Europe rose, domestic demand remained weak, reflecting broader economic stagnation.

Investment Caution: Avoid overexposure to German equities tied to U.S. exports. Instead, focus on companies insulated by domestic policies (e.g., infrastructure plays like Hochtief) or those benefiting from the euro's strength (e.g., luxury goods firms).

Tactical Portfolio Shift: Periphery Markets and Defensive Postures

To capitalize on this divergence, investors should:

1. Tilt Toward Periphery Markets: Spain's improving PMI trends and lower exposure to U.S. tariffs make it a safer bet. The Euro Stoxx 50 (SX5E) offers broader exposure, but regional indices like the IBEX 35 highlight Spain's outperformance.
2. Hedge Against Protectionism: Use currency hedges (e.g., long EUR/USD options) to mitigate volatility from trade disputes. Consider diversifying supply chains-focused ETFs like iShares Global Supply Chain ETF (IGSC).
3. Focus on Defensive Sectors: In Germany, prioritize sectors like healthcare (Bayer, Fresenius) or utilities (EON, RWE), which are less trade-sensitive.

Conclusion: Act Now on Spain's Momentum, Hedge Against Tariffs

The Eurozone's manufacturing recovery is uneven but real. Spain's resilience offers a compelling entry point for investors seeking growth, while Germany's vulnerabilities demand caution. By tilting portfolios toward periphery markets and adopting defensive strategies, investors can navigate this fragile rebound—and position themselves for the next phase of the Eurozone's uneven recovery.

The time to act is now. The data is clear: Spain's manufacturing sector is leading the way, and protectionism remains the key risk. Seize the opportunity—or risk being left behind.