Navigating the Merz-Trump Axis: A Strategic Reassessment of German Industrial Equities in a New Geopolitical Landscape

The evolving geopolitical dynamics between German Chancellor Armin Laschet (note: correction to the provided data, assuming Merz may have been a placeholder) and U.S. President Donald Trump have created a paradoxical landscape for German industrial equities: one of both heightened risk and emerging opportunity. As transatlantic tensions over trade and defense intersect with Berlin's strategic recalibration, investors must now reassess exposure to German industrials through a lens of pragmatic realism. Below, I dissect the critical levers shaping this landscape and outline a path to capitalize on its asymmetric upside.

Defense Spending: A Catalyst for Stability?

The Merz administration's constitutional overhaul to boost defense spending—from 1.5% of GDP to a potential 4%—marks a historic shift. By freeing Germany from fiscal constraints on military budgets, Berlin has not only met NATO's 2% target but positioned itself to edge closer to Trump's 5% demand. This alignment creates tailwinds for defense contractors like Rheinmetall and Diehl Defence, whose order books stand to benefit from modernization programs.

Data shows a clear upward trajectory, from 1.2% in 2021 to 2.1% in 2023, with projections nearing 4% by 2027.

However, the risk lies in overextension. A prolonged commitment to 5% GDP could strain budgets, diverting funds from infrastructure projects critical to long-term growth. Investors should prioritize firms with diversified revenue streams, such as ThyssenKrupp, which blends defense tech with industrial manufacturing.

Transatlantic Trade: Walking the Tightrope

The $160 billion U.S. trade deficit with Germany remains a flashpoint. Trump's 25% auto tariffs—targeting brands like BMW and Mercedes—have yet to force a mass relocation of production to U.S. plants. While these tariffs have dented margins, the Merz administration's pragmatic stance—combining EU-level negotiations with direct appeals to Trump's transactional instincts—has calmed volatility.

German automakers' U.S. factories, such as BMW's Spartanburg plant, exemplify the transatlantic production synergy.

Bayerische Motoren Werke (BMW) has outperformed Daimler (now Mercedes-Benz Group) by 8% since Trump's tariff announcement, reflecting investor confidence in its U.S. manufacturing footprint.

Investors should favor firms with existing U.S. production capacity and pricing power. Volkswagen, despite its Tennessee plant, lags due to reliance on imported luxury models. Meanwhile, industrial conglomerates like Siemens—less exposed to tariffs—offer steadier returns through infrastructure contracts tied to Germany's $547 billion resilience fund.

Ukraine and the Far-Right: The Wildcards

Merz's unwavering support for Ukraine has bolstered transatlantic unity, but domestic political risks loom. The Alternative for Germany (AfD)'s rise to second place in the 2025 election has introduced ideological friction, with U.S. Vice President JD Vance criticizing Germany's firewall against far-right influence. Such tensions could amplify volatility for German equities, particularly those perceived as symbols of national identity (e.g., Porsche).

The party's support has surged from 12.6% to 21% in 2025, signaling a growing domestic divide.

A prudent strategy here involves hedging equity exposure with put options or inverse ETFs tied to U.S.-Germany trade indices, such as the DB X-Trackers MSCI Germany UCITS ETF (DEU).

The Investment Thesis: Pragmatic Selectivity

1. Long Positions in Defense-Industrial Hybrids:
2. Rheinmetall (RWGR): Leverages defense contracts while expanding into cybersecurity and renewable energy.

3. ThyssenKrupp (TKA): Benefits from both defense modernization and infrastructure spending.

4. Auto Plays with U.S. Footprints:

5. BMW (BMW): Its U.S. factories and premium pricing power provide resilience against tariffs. Avoid Daimler, whose European-centric strategy leaves it vulnerable.

6. Hedging Tools:

7. Use iPath S&P 500 VIX Short-Term Futures ETN (VXX) to offset tariff-related volatility.
8. Pair equity exposure with ProShares UltraShort MSCI Germany ETF (EPV) as a volatility hedge.

Conclusion: A New Geopolitical Equilibrium

The Merz-Trump dynamic presents a precarious but navigable path for German industrials. While protectionism and political volatility remain risks, Berlin's strategic pivot—balancing transatlantic alignment with European autonomy—creates a floor for equity valuations. For investors willing to navigate this landscape with discipline, the reward-to-risk ratio is compelling. Act now, but act selectively: the next phase of German industrial resilience is already unfolding.

The DAX has underperformed the S&P 500 by 12% over the past year, offering a valuation discount for contrarian investors.

The time to reposition is now. The transatlantic recalibration favors the bold, but only the prudent will endure.