Markets Insight
Last updated: October 2, 2012 8:25 pm
China shock poses risk to German export drive
Germany celebrates “unity day” on Wednesday, marking the rejoining in 1990 of the country’s east and west, with the eurozone debt crisis far from resolved. But German stockholders have an excuse for feeling smug. Despite the crisis – or because of it – the Dax share index has powered ahead of the rest of the eurozone, and even outperformed US and world equities since the start of this year.
On one view, the Dax’s relative strength is surprising. True, reforms implemented a decade ago put Germany’s economy in enviable shape to ride the economic storms of the past few years.
Worries about the eurozone have also eased, thanks to a pledge by Mario Draghi, European Central Bank president, to do “whatever it takes” to preserve the euro: the threat of Europe’s monetary union breaking up, spelling catastrophe for Germany as well as the continent generally, has receded.
But Germany has an important weak spot. With exports equivalent to 50 per cent of its economy, it depends on global growth. Asia accounts for 11 per cent of Dax companies’ sales, and with worries mounting of a hard landing for China, Germany looks vulnerable.
Reflecting the intertwined fates of the German and Chinese economies, the Dax and Chinese share prices have largely risen and fallen in tandem since the early 2000s. Lately, however, that relationship has appeared to break down. While internationally-traded Chinese shares have fallen about 1 per cent since early August, the Dax is up 8 per cent.
If worries were really rising about China’s prospects, one might have expected the Dax to have taken more of the brunt. Instead, different Teutonic factors prevail.
The Dax provides exposure not just to China but to other emerging markets, as well as to stable western European economies (the eurozone crisis permitting). It focuses on well-known industrial brands such as Siemens, Volkswagen and BMW. It is light on companies exposed to the volatile commodities sector.
German companies have also had a knack of under-promising and over-delivering. Since the beginning of the year, expectations about Dax companies’ earnings for the 12 months ahead have risen by 7 per cent – compared with a 2 per cent fall for European stocks overall, according to Deutsche Bank.
But what is particularly interesting for eurozone watchers is the centripetal force that has sucked funds back into the region’s “core”, centred on Germany, its largest economy. While Germany celebrates its “unity”, the eurozone is fragmenting: European banks have retrenched behind national borders, interest rates vary wildly between north and south Europe, and investors have withdrawn from crisis-hit “periphery” countries.
The impact of “financial fragmentation” is obvious in government bond markets. While borrowing costs soared in the eurozone “periphery” in 2011, yields on two-year German debt fell sharply. They turned negative earlier this year before returning to (slightly) positive territory.
Investors seeking better returns moved into other assets – including equities. Assets under management in German equity funds expanded last year by almost 40 per cent, according to EPFR, a data provider, compared with a near 3 per cent contraction in western European funds overall – although those flows have partly reversed this year.
Watch the eurozone crisis from Berlin, Frankfurt or Munich and a different perspective emerges. Historically low interest rates have fuelled fears of asset price bubbles. House prices have jumped in some urban areas – not dramatically by global standards but worryingly for Germans not used to the value of their homes varying by much.
There is a risk of a snapback in bond markets, if economic conditions improve and investor confidence returns in the rest of the eurozone.
Against that background, the Bundesbank’s concerns about the European Central Bank’s ultra-loose monetary policy and plans to support government debt markets to preserve the eurozone’s integrity are easier to understand. The deeper fear is policy actions are creating long-term inflation threats.
It is far-fetched to suggest German equities are expensive. The price to forward-looking earnings ratio for the Dax, at about 10.4, is in line with its five-year average and at a discount to Europe overall. Nor would it be sensible to overstate the extent to which Germany has profited from the crisis: it would benefit much more from an easing of its intensity.
After all, almost 40 per cent of Germany’s exports are to other eurozone countries. At the same time, a Chinese hard landing would amount to a serious shock to German corporates. But the Dax’s performance is a reminder of the distortions being created by the eurozone’s fragmentation.
.
The writer is the FT’s capital markets editor
.
On one view, the Dax’s relative strength is surprising. True, reforms implemented a decade ago put Germany’s economy in enviable shape to ride the economic storms of the past few years.
Worries about the eurozone have also eased, thanks to a pledge by Mario Draghi, European Central Bank president, to do “whatever it takes” to preserve the euro: the threat of Europe’s monetary union breaking up, spelling catastrophe for Germany as well as the continent generally, has receded.
But Germany has an important weak spot. With exports equivalent to 50 per cent of its economy, it depends on global growth. Asia accounts for 11 per cent of Dax companies’ sales, and with worries mounting of a hard landing for China, Germany looks vulnerable.
Reflecting the intertwined fates of the German and Chinese economies, the Dax and Chinese share prices have largely risen and fallen in tandem since the early 2000s. Lately, however, that relationship has appeared to break down. While internationally-traded Chinese shares have fallen about 1 per cent since early August, the Dax is up 8 per cent.
If worries were really rising about China’s prospects, one might have expected the Dax to have taken more of the brunt. Instead, different Teutonic factors prevail.
The Dax provides exposure not just to China but to other emerging markets, as well as to stable western European economies (the eurozone crisis permitting). It focuses on well-known industrial brands such as Siemens, Volkswagen and BMW. It is light on companies exposed to the volatile commodities sector.
German companies have also had a knack of under-promising and over-delivering. Since the beginning of the year, expectations about Dax companies’ earnings for the 12 months ahead have risen by 7 per cent – compared with a 2 per cent fall for European stocks overall, according to Deutsche Bank.
But what is particularly interesting for eurozone watchers is the centripetal force that has sucked funds back into the region’s “core”, centred on Germany, its largest economy. While Germany celebrates its “unity”, the eurozone is fragmenting: European banks have retrenched behind national borders, interest rates vary wildly between north and south Europe, and investors have withdrawn from crisis-hit “periphery” countries.
The impact of “financial fragmentation” is obvious in government bond markets. While borrowing costs soared in the eurozone “periphery” in 2011, yields on two-year German debt fell sharply. They turned negative earlier this year before returning to (slightly) positive territory.
Investors seeking better returns moved into other assets – including equities. Assets under management in German equity funds expanded last year by almost 40 per cent, according to EPFR, a data provider, compared with a near 3 per cent contraction in western European funds overall – although those flows have partly reversed this year.
Watch the eurozone crisis from Berlin, Frankfurt or Munich and a different perspective emerges. Historically low interest rates have fuelled fears of asset price bubbles. House prices have jumped in some urban areas – not dramatically by global standards but worryingly for Germans not used to the value of their homes varying by much.
There is a risk of a snapback in bond markets, if economic conditions improve and investor confidence returns in the rest of the eurozone.
Against that background, the Bundesbank’s concerns about the European Central Bank’s ultra-loose monetary policy and plans to support government debt markets to preserve the eurozone’s integrity are easier to understand. The deeper fear is policy actions are creating long-term inflation threats.
It is far-fetched to suggest German equities are expensive. The price to forward-looking earnings ratio for the Dax, at about 10.4, is in line with its five-year average and at a discount to Europe overall. Nor would it be sensible to overstate the extent to which Germany has profited from the crisis: it would benefit much more from an easing of its intensity.
After all, almost 40 per cent of Germany’s exports are to other eurozone countries. At the same time, a Chinese hard landing would amount to a serious shock to German corporates. But the Dax’s performance is a reminder of the distortions being created by the eurozone’s fragmentation.
.
The writer is the FT’s capital markets editor
.
Copyright The Financial Times Limited 2012.
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