The UBS German Fiscal Reform basket ({UBXEGFIS}) has been on a tear, rallying 21% year-to-date (YTD) and securing its place as the second-best performing investment theme of the year. This impressive surge reflects growing investor confidence in Germany’s domestically oriented stocks, particularly those poised to benefit from higher public spending on infrastructure and defense.

Defense Stocks Drive Optimism in Fiscal Expansion

Breaking down the YTD gains, one-third of the rally is attributed to defense-related names, signaling that investor optimism isn’t just limited to military spending but extends to broader public investment. This comes as Germany continues to navigate economic challenges while eyeing significant fiscal reforms.

Elections and the Fiscal Reform Outlook

Germany heads to the polls on February 23, and expectations for fiscal expansion are rising. UBS Economics has raised the probability of a “growth boost scenario,” in which significantly higher fiscal spending and structural reforms could elevate Germany’s potential economic growth.

Key political parties are aligning on the fiscal front:

• The Greens and Social Democrats (SPD) are advocating for debt brake reform to enable greater fiscal flexibility.
• The CDU has signaled a willingness to discuss modifications to Germany’s strict debt rules.

Currently, these three parties collectively hold 69% of parliamentary seats—just enough to pass constitutional reform on fiscal policy. Even without a formal two-thirds majority, alternative pathways exist, such as activating the “debt brake escape clause” to create more fiscal space.

Defense Stocks Continue to Climb Amid EU Discussions

Meanwhile, the UBS Defence basket ({UBXESPND}) continues its strong run, climbing 2% on Tuesday after Monday’s record-breaking 10.7% rally, its best single-day gain since the COVID-19 era.

This surge follows a high-stakes EU leaders’ meeting in Paris, where discussions focused on European defense strategy amid geopolitical tensions. While no clear consensus emerged on potential military intervention in Ukraine, leaders broadly agreed on the need to ramp up defense spending. Potential funding mechanisms on the table include:

• Eurobonds
• Utilizing the European Stability Mechanism (ESM)
• Exemptions from EU deficit rules for defense spending

Market Implications Moving Forward

With elections on the horizon and growing momentum for fiscal expansion, investors are watching closely for policy shifts that could further boost Germany’s economy. If fiscal reforms materialize, the German Fiscal Reform and Defense baskets could continue their impressive rally, positioning them as key themes for 2024.