Europe's leaders are unpopular, but Germany's Merz is losing support fastest

Greens top the Baden-Württemberg vote with 30.2% while AfD rises to 18.8%, signalling a setback for Chancellor Friedrich Merz and eroding support for the CDU; Merz's net approval plunged 34 points to -48 (Feb 2026 vs -14 in June 2025). Domestic ZDF polling shows 54% rate Merz's performance as poor and only 34% think he can lead the CDU forward; he scores -0.5 on a +5 to -5 popularity scale (Defence Minister Pistorius +2.1). The decline is attributed to disappointment over slow reform delivery and constrained fiscal choices amid international crises (eg, Russia's invasion of Ukraine), implying potential upward pressure on defence spending and policy uncertainty. For portfolios, expect modest political-risk-driven volatility in German assets and sensitivity in defence and fiscal-exposed sectors rather than broad market moves.

Analysis

The rapid deterioration in political capital for Germany’s governing party increases the chance of policy drift over the next 6–18 months, which is a non-linear headwind for cyclical capex projects and corporate restructuring plans. Markets typically price such drift via higher idiosyncratic vol and wider equity risk premia for domestically exposed names, even absent immediate fiscal shock—expect muted M&A, delayed tax/regulatory rollouts and capital-expenditure deferrals as managements adopt a wait-and-see stance.

A clear beneficiary path is defense and heavy infrastructure: when governments reallocate scarce budgetary room toward security spending, procurement timelines lengthen but contract values grow and become stickier across multi-year horizons (12–48 months). Conversely, regions where greener administrations gain influence tend to accelerate subsidies and infrastructure for electrification at the state level, creating concentrated demand for charging, battery supply, and local engineering services — a sectoral rotation rather than a broad growth impulse.

Tail risks cluster around two outcomes: a material shift toward anti-establishment parties would elevate political risk premia, trigger capital reallocation out of Germany, and could weaken the euro over months; a faster-than-expected delivery of headline reforms (tax cuts, visible business-friendly wins) would reverse sentiment quickly and compress volatility within weeks. For investors, the right playbook is asymmetric exposure to long-duration defense/infrastructure earnings while using compact, hedged positions to express short-term political uncertainty in domestic cyclicals.

Key Decisions for Investors

• Buy Rheinmetall (RHM.DE) 6–24 month long — initiate 1–2% NAV exposure, scale in on 5–10% pullbacks. Rationale: multi-year defense procurement increases with sticky revenue profiles; target asymmetric upside of 25–50% if major contracts are announced, downside 20–30% (operational/contract timing risk).
• Buy HENSOLDT (HAG.DE) 6–18 month long — 0.5–1% NAV position via stock or tight-dated calls. Rationale: sensors/electronics are high-priority items in accelerated defense budgets; expect margin expansion on recurring service contracts. Manage risk with 20% stop or roll to longer-dated calls if headlines slow.
• Pair trade (market-neutral): Long RHM.DE 1% NAV / Short Continental (CON.DE) 1% NAV for 6–12 months. Rationale: directional hedge captures rotation into defense/infrastructure vs. downside in auto supply-chain sensitivity to regulatory-driven capex and localized policy shocks. Aim for 2:1 upside/downside asymmetry; trim on converging news flow.
• Buy downside protection on German equity exposure: EWG (iShares MSCI Germany) 9–12 month 7–10% OTM puts sized 0.5–1% NAV as a tail hedge. Rationale: inexpensive insurance against a political-risk spike or larger capital flight; payoff is convex if volatility re-prices sharply following further regional election surprises.