European markets have spent much of the past year trailing the United States, and investors are now pinning their hopes on a potential spending surge in Germany to change the narrative in 2026. As the European Union’s largest economy, Germany’s fiscal choices are seen as pivotal—but markets want proof that promised spending will translate into lasting growth.
Another possible tailwind is progress toward peace in Ukraine. European equities have yet to fully recover the capital that exited the region following Russia’s invasion in 2022, and any easing of geopolitical tensions could help restore confidence.
Europe did enjoy a brief revival in the first half of 2025, when its stocks outperformed U.S. markets. The continent rallied around higher defense spending, Germany loosened its borrowing rules, and trade tariffs introduced by U.S. President Donald Trump unsettled investors’ appetite for American assets. The moment was dubbed “MEGA”—Make Europe Great Again.
That momentum, however, proved short-lived. As tariff fears faded, European shares slipped back into their familiar pattern of underperforming U.S. equities, even as markets continued to rise overall. The euro, meanwhile, remains below its four-year high of nearly $1.20, reached in September.
Fund flows tell a similar story. European equities attracted just over $86 billion in inflows in 2025, but only $23 billion of that arrived in the past six months, according to EPFR data compiled by Barclays. While analysts expect Europe to perform reasonably well next year, most major investment banks still see the region lagging the United States, particularly because U.S. markets have greater exposure to the booming artificial intelligence sector.
Currency prospects are equally uncertain. Much will depend on the direction of the U.S. dollar, with some banks predicting the euro could weaken despite its strong gains earlier this year.
Attention is now firmly on Germany’s fiscal strategy. Although Berlin has more room to spend, critics say much of the money is being channeled into social and day-to-day expenditure rather than productivity-boosting infrastructure. While infrastructure investment is expected to increase in 2026, economists warn that social spending is rising faster in the near term.
Germany’s plans have drawn mixed reviews from investors. Some see high overall spending as supportive, but others argue that without a stronger focus on infrastructure and structural reforms, the long-term economic impact may be limited. Concerns about execution are also growing, especially after leading economic institutes recently downgraded Germany’s 2026 growth outlook.
Valuations suggest markets remain skeptical. European stocks trade at around a 35% discount to their U.S. counterparts based on forward earnings, a level close to records. While German shares are up about 20% this year, gains have stalled in the second half, underscoring lingering caution.
Still, that pessimism could turn into opportunity. Investors say Europe could attract significant inflows if Germany delivers on its plans and sentiment improves. Expectations for a rebound in corporate earnings next year, after a contraction in 2025, could also add momentum.
A breakthrough in Ukraine would further support confidence, particularly through lower energy prices and the prospect of reconstruction projects that could run into hundreds of billions of dollars over the next decade.
For now, however, Europe’s outlook—and the euro’s direction—remain closely tied to developments in the United States. Despite a strong run in 2025, analysts note that global markets are still largely driven by U.S. economic conditions and Federal Reserve policy, leaving Europe waiting for a catalyst that can finally pull it out of America’s shadow.