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Germany’s economy shrank last quarter, one of its biggest trading partners is ailing and the government is deeply unpopular. And yet the country’s benchmark stock index just made a record high.
That disconnect has investors wondering whether the DAX Index can add to this year’s 13% gains, given that measures of investor and business confidence point to further sluggishness ahead for the economy.
The rally is all the more remarkable because one of the country’s most high-profile industries, autos, is in a slump. Shares of Volkswagen AG, BMW AG and Porsche AG are all down 11% or more in 2024, hurt in part by weakness in China, a key trading partner. VW said Monday it’s considering its first-ever factory closures in Germany.
“Companies are clearly giving up more and more hopes that the economy will pick up,” said Ralph Solveen, an economist at Commerzbank AG. “This does not bode well for the German economy in the coming months.”
Stocks in Germany got caught up in the global market selloff in early August, erasing much of the year’s gain. But the DAX has come roaring back, gaining 9.2% from its Aug. 5 low through Monday’s record close of 18,930.85.
Investors didn’t see the August rally coming, so it’s probably been painful for many of them: Germany last month became by far the least-preferred market in Europe in Bank of America Corp.’s survey of fund managers.
In part, the DAX has been resilient because it’s loaded with exporters who are less tied to German growth than smaller companies. The DAX Mid-Cap Index, by contrast, is down 5.4% this year and is still about 30% below its 2021 record.
Signs of risk abound: While shares of Germany’s banks are doing fine, lenders increased their provisions for bad loans by almost 50% in the first half. Why? Corporate insolvencies rose almost 30% in the period, hitting the highest level in a decade, according to consumer credit rating firm Creditreform.
And Germany faces growing political uncertainty in the runup to next year’s national election. Chancellor Olaf Scholz’s Social Democrats and his coalition partners suffered losses to populist parties in Sunday’s regional elections. The outcome will “likely put further strains on the federal government coalition,” according to Deutsche Bank AG economists Marion Muehlberger and Ursula Walther.
The outlook isn’t helped by ongoing weakness in China, a major trading partner for Germany. China’s factory activity contracted for a fourth straight month in August and the country is still struggling with a prolonged property downturn and weak consumer activity. Trade tensions with the country are another headwind.
Despite all that, investors see a brighter future for the companies in the large-cap index. They now value the DAX at almost 13 times estimated earnings, up from less than 10 times in October, the recent valuation low point.
Much of the rerating this year has been driven by SAP SE, according to Bloomberg Intelligence strategists Kaidi Meng and Laurent Douillet. The German software company, a beneficiary of the frenzy around artificial intelligence. SAP now has a 15% weight in the index and its forward price-earnings ratio has jumped this year from 23 to 35, the highest in at least 20 years.
Strategists say it’s hard to see what might drive another leg in the rally.
“The German market faces a cautious second-half outlook given faltering earnings momentum, a large exposure to China, sector-specific risks and a European cyclical recovery that’s unlikely to emerge,” the Bloomberg Intelligence strategists said. “The DAX needs new valuation catalysts to unlock upside.”
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