4th Quarter 2025 Mar­ket Up­date: Ger­man equit­ies de­fied a poor eco­nomy

Our overall house view for global equities is positive, with the potential for double-digit upside for the S&P 500 over the next 12 months. U.S. growth may benefit from a smaller tariff drag, tax cuts, and easier financial conditions. The rationale is based on assumptions that include continued Fed rate cuts, an accelerating economy and no recession, and long-term interest rates to remain below 4.5% in the U.S. U.S. earnings growth is projected at 10%+ for the next five years, with robust earnings growth also anticipated globally. Short-term caution may be rewarded due to record-low cash levels amongst institutional investors and a very bullish sell-side sentiment, which could be a contrarian signal. Over-investment concerns in AI infrastructure are also noted.

Within equities DWS currently prefers European equities over U.S. equities. All major European economies are likely to underperform the US in terms of GDP growth. The growth problem is particularly acute in Germany, France and Italy. However, in the short term, Germany should benefit from a strong fiscal impulse. The preference for European equities is based on a diversification argument, relatively cheaper valuations while having decent earnings growth, and a higher cyclical exposure. Factor diversification could be a big driver of equity performance in 2026. Investors are increasingly looking to diversify their portfolios away from the AI narrative and away from US assets. European equities still trade at a significant discount to their U.S. peers despite the strong performance in 2025. Additionally, U.S. markets seem to become less predictable due to political, fiscal and trade-related uncertainties. Europe should benefit from German fiscal stimulus, stabilizing economic conditions, improving early indicators and not the least from strong capital flows as international investors continue diversifying away from technology giants and U.S. markets.

Germany’s equity market has very little to do with the domestic economy, as more than 80% of the blue-chip index DAX earnings are generated internationally. The market has regained momentum with the DAX delivering a strong 2025 performance, initially driven by fiscal stimulus announcements and renewed foreign capital inflows, before sentiment cooled off, on overly optimistic expectations and U.S. tariff uncertainties. Looking ahead to 2026, business expectations are improving as companies benefit from cost adjustments, easing macro headwinds, and stimulus linked demand. In Germany, earnings growth of roughly 10% to 12% is forecast, led by autos and industrials, and we expect profit expansion expected to be the primary driver of further market gains, but would not rule out multiple expansion. Market breadth is widening beyond a few large names, and sectors tied to defense spending, infrastructure, and a cyclical industrial recovery appear well positioned. While geopolitical risks, delays in Germany’s infrastructure rollout, and U.S. economic weakness remain key risks, German equities continue to trade attractively versus Europe and the U.S., with potential for further upside—especially if economic conditions improve and stimulus effects materialize later in the year. The ECB is likely done cutting rates, although the risks remain tilted to the downside with inflation now being close to 2% in the Euro area and encouraging signs of a slowdown in the UK, as well.

Since 2025, nearly all major equity markets have outperformed the US in local and in USD terms. Still, Europe as a whole, and Germany in particular is trading at a deep discount to the US. All sectors in Europe are on a wider-than-usual discount to their US counterparts, but not all sectors in Europe have lower net income growth than the U.S. sectors. Adjusted for growth price/earnings to growth (PEG) ratio, Europe is still trading at a reasonable multiple of 1.1 times. Within sectors, we prefer companies with higher domestic exposure than U.S. or Chinese exposure. European and German small caps remain cheap, as they have just broken out of an almost 5-year period of underperformance versus the large caps.