For much of the period since the global financial crisis, corporate Europe has struggled to keep pace with the US. Economic growth has been weaker, investment has been lower and European stock markets have lacked meaningful exposure to the technology giants that have played such an outsized role in driving global equity returns.
Germany, once regarded as Europe’s industrial engine, has come to exemplify the problem. The country has endured years of stagnation as higher energy costs, weak export demand, ageing infrastructure and growing competition from China have weighed on its manufacturing-led economy. Indeed, the country endured two consecutive years of recession as recently as 2023 and 2024.
Moreover, a widespread allergy to government debt – even to fund desperately-needed investment in railways, roads, electricity networks and digital infrastructure – was codified by the Schuldenbremse, or debt brake, limiting annual structural federal net borrowing to a paltry 0.35% of GDP.
Therefore, a stark recent change of direction in the country has been both very welcome and very significant. Chancellor Friedrich Merz’s government has loosened Germany’s constitutional borrowing restrictions, creating a multi-year commitment through a €500bn infrastructure fund, the Special Fund for Infrastructure and Climate Neutrality.
As recently as early July, the ruling coalition finalised a 34-point ‘programme for growth and employment’, covering everything from cutting red tape for business to raising the bar for employees taking sick days.
Then there is the step-change in defence spending, specifically Germany’s decision to exempt much of it from the debt brake, coupled with a target of spending 3.1% of GDP on defence by 2027 and 3.7% by 2030.
This is at a time of severe doubts over the reliability of US support for Europe, even with the looming threat from Russia. The moment that crystallised this risk for Germans was the Russian invasion of Ukraine in 2022, which led directly to the Zeitenwende, or epochal change.
This was a paradigm shift announced by Merz’s predecessor Olaf Scholz, overhauling Germany’s post-World War II security strategy and permanently altering its relationship with Russia. The return of Donald Trump to the White House only served to further entrench this need for change.
Much of the immediate impact of these changes will be felt in the corporate sector. Specifically, construction groups, engineering companies, defence contractors and businesses supplying technology for transport and power infrastructure should all benefit from increased demand.
In addition, better infrastructure across the country could reduce costs over the long term, improving productivity and giving private companies greater confidence to invest.
An opportunity for European smaller companies
The potential beneficiaries are not confined to Germany’s largest businesses. Smaller European companies are often more closely exposed to domestic investment, construction and manufacturing supply chains than the continent’s multinational giants.
They may therefore benefit disproportionately if public spending encourages businesses to increase their own capital expenditure.
This opportunity extends across the IT European Smaller Companies investment trust sector. European Smaller Companies Trust (ESCT), for example, currently has 23% of its portfolio in Germany and almost 30% in industrial companies. JPMorgan European Discovery (JEDT) has less direct German exposure, at around 9%, but industrials account for approximately a third of the portfolio.
Montanaro European Smaller Companies
Within this peer group, Montanaro European Smaller Companies offers a more concentrated quality-growth approach, with particular exposure to specialist industrial and technology companies.
The trust has never been a direct bet on the German economy, but its portfolio contains many of the specialist industrial and technology businesses that stand to benefit.
Its manager George Cooke focuses on high-quality growth companies operating in often niche markets. Industrials (31% of the total as at 30 June 2026) and technology (29%) account for a significant share of the portfolio.
Holdings such as Carel Industries (3.8% of the portfolio) and Belimo (4%), for example, provide systems used to improve the efficiency of heating, ventilation and air-conditioning equipment. Investment in upgrading commercial premises, hospitals and other buildings could support demand for their products over time.
When it comes to defence, Montanaro European Smaller Companies does not own the large weapons manufacturers that have already enjoyed substantial share-price gains. Its exposure is instead concentrated among specialist suppliers.
Invisio (2.5% of the portfolio) produces communication and hearing-protection systems for military and public-safety customers, while Kitron (4.6%) manufactures electronic components for defence, aerospace, industrial and medical companies.
This indirect exposure should prove beneficial to MTE as the knock-on effects of increased defence spending spread through supply chains.
Germany is only the trust’s third-largest country exposure, at 17% of the total. However, European industrial supply chains are highly integrated, meaning a revival in German capital expenditure could also benefit specialist suppliers listed elsewhere on the continent.
The shift by Europe’s largest economy may also give other governments greater political cover to increase their own investment, widening the potential opportunity beyond Germany itself.
There are risks
Such big changes inevitably also bring risks. Clearly, approving large sums of money is much easier than deploying them productively, and Germany’s planning rules, procurement systems and bureaucracy have repeatedly delayed major infrastructure projects in the past.
There is also the risk that investors expect too much, too soon. Infrastructure projects can take years to approve and complete, while defence companies and some industrial stocks have already rerated sharply. Higher government borrowing could also push up bond yields, partially offsetting the benefit for growth companies whose valuations are sensitive to interest rates.
Most importantly, additional spending will not resolve all of Europe’s structural disadvantages. Germany and other European countries still face ageing populations, high energy costs, and in many cases excessive regulation, often at an EU-level.
Indeed, partly as a result of a cautious approach to emerging technologies, Europe remains far behind the US and China in artificial intelligence and mega-cap technology, which may hold its corporate champions back, and continue to weigh on relative equity-market performance.
But change is unquestionably welcome
Yet Europe does not need to recreate Silicon Valley for the spending reset to make a difference. The region retains considerable strengths in advanced manufacturing, semiconductor equipment and elsewhere – precisely the areas that should benefit from a sustained recovery in public and private investment.
Therefore, Germany’s fiscal reset should be seen as an important step rather than a complete solution. It cannot immediately reverse years of underinvestment or close Europe’s technology gap with the US. Nor will every euro of spending translate neatly into higher profits.
Nevertheless, what Germany’s spending reset clearly does is create a more supportive backdrop for corporate Europe than the austerity-led model it replaces. For investors willing to look beyond the region’s largest companies, it could provide the catalyst for a long-awaited improvement in investment, productivity and business confidence.
Montanaro European Smaller Companies appears well placed to participate in that improvement – although the benefits are likely to mainly be indirect and will depend on how effectively the new spending is deployed.
David Batchelor is senior fund analyst at QuotedData. The views expressed above should not be taken as investment advice.