Europe’s tipping point: investing in strategic autonomy

Europe’s leaders are urgently reconsidering their spending priorities, particularly in the defence sector, as the US threatens to turn its back on former partners.

Just as Europe has depended on the US for its defence over many decades, so global investors have often relied on returns from US financial assets.

These old certainties are changing fast. Europe’s geopolitical wake-up call from the administration of president Donald Trump has catalysed long-term public spending commitments, as the continent unites around a common objective. That will generate fresh opportunities in financial markets.

As the new US government redraws the global order, sidelining Europe, our region and Germany in particular have scrambled an historic response with far-reaching consequences. This looks like an 11^th hour effort for European economies. The current transatlantic rift is generating a response to the fundamental question: can Europe rely on Mr Trump and a US-led Nato for their security?

That the US administration no longer shares Europe's democratic values is clearer than ever. We are suddenly considering the reality that the US may become an economic rival rather than an ally. The language of ‘America First’ is already translating in the capitals of Europe into tough strategic choices and plans for greater economic, military and diplomatic autonomy from the US.

There is now a real chance that President Trump, along with Vladimir Putin, will trigger a result that neither seemingly wants. They are uniting the Western world, minus the US, and so creating a catalyst for what they look to be trying to temper: a unified Europe allied with other Western countries such as Canada and Australia. The world’s geopolitical map is being redrawn as we watch.

Unwritten trade pact

At the trade level, the Trump administration is dismantling an unwritten pact which has spanned recent decades: Americans buy European goods, and in return Europeans buy American services, and invest in US financial assets. The Trump administration neglects to notice that the US has a trade surplus with Europe in services. Foreign investment therefore serves to support the US’s ability to finance its budget and trade deficits, while lowering consumer borrowing costs and underpinning US dollar’s strength.

In this context, European markets’ recent outperformance, and the acceleration of capital flows out of the US and into Europe, following three years of global outflows and underperformance, is remarkable. At the start of 2025, European valuations were at record discounts compared with global and US equity markets. Since then, US tariffs have been slower-than-expected to materialise, and European commercial banks continue to deliver strong results.

Europe's package of fiscal responses is now improving the region's growth outlook and we expect interest rate cuts by the European Central Bank, taking its benchmark rate towards 1.75 per cent by the year-end.

Can Europe continue to outperform? In the near term, much of the improvement looks incorporated in prices, and the market faces strong headwinds from potential US tariffs. The impact of the new fiscal boost will be a key variable. On a three-to-six month investment horizon, we prefer cyclical sectors such as luxury cars and personal goods, or semiconductors, over defensives for global equity portfolios. We believe investors should focus on diversifying portfolios and seize opportunities in defence, infrastructure and renewable energy sectors.

Wider investment choices

Longer-term, co-ordinated European efforts to invest in the continent’s infrastructure, militaries and technology could widen global investors’ choices. And as we have just seen, we should not underestimate Europe’s ability to act under pressure. Despite the region’s challenges, there are solutions, and now US policy is supplying the motivation for contemplating real change. Moreover, Europe has the means to raise fresh debt and implement strategic initiatives, as it demonstrated through the Covid-19 pandemic.

Europe is at a tipping point, and while daunting, the challenges offer a chance for the continent to assert its strategic independence and secure its future. Investments, along with more politically stable core governments, can help to make it a more appealing prospect for international investors.

Deterrence is cheaper than war, and as Europe is recognising, maybe belatedly, investment is a prerequisite for economic resilience and autonomy over the long run.

Michael Strobaek, global CIO private bank, Lombard Odier