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Not long ago, the German economy was the envy of Europe. It had low unemployment, sound fiscal policies and exported luxury cars and value-added industrial goods to a growing global economy. Germany was a poster child for the benefits of globalization. However, recent years have not been so kind.
There is virtually no economic growth, business bankruptcies are soaring, and the once-competitive German industrial giants are fighting for survival. Given the dim outlook, one might find it odd to see the DAX index make new all-time highs. How can the stock market be so strong when the economy is so weak?
The DAX
Global X Dax Germany ETF
, the German blue-chip stock market index that tracks the performance of the 40 largest companies trading on the Frankfurt Stock Exchange, is up 11.8%, significantly higher than the 7.5% return for the European-wide SX5E index.
The strong stock market performance has come despite lackluster GDP growth. The German economy shrank 0.1% in 2023, and growth is expected to be close to 0% in 2024 and will likely accelerate to just 0.8% in 2025.
Industrial production is 10% below pre-pandemic levels, and the latest release of German composite PMI decreased further to 48.4. Manufacturing PMI was an abysmal 42.4, levels only reached during the Global Financial Crisis or the COVID Crisis.
There are two main culprits behind the decline. The first is the shock attributed to the spike in energy costs following Russia’s invasion of Ukraine. The German industrial machine was highly dependent on cheap gas imported from Russia, and skyrocketing gas prices caused a 20% decline in energy-intensive industries, according to the IMF, and shaved 1.25% off of potential output.
The second blow to Germany’s industrial complex came from China. China’s economic contraction has paused Chinese consumers’ once-insatiable demand for luxury cars from companies like BMW, Porsche, and Mercedes Benz. BMW’s sales in China fell by 3.8%, Mercedes-Benz by 12%, and Porsche by 24% in the first quarter of 2024. These companies face intense competition from local Chinese manufacturers offering lower-cost electric vehicles.
China’s pivot away from real estate toward exports of value-added industrial goods is also pressuring German companies. Heavy subsidized Chinese EVs are flooding the European market, hurting the German automotive industry, which accounts for 17% of aggregate exports.
The German economy is no longer a European pillar of strength, but the strength of the widely followed DAX would indicate otherwise.However, the DAX is unique.
Similar to the situation in U.S. markets, where a handful of technology stocks have been responsible for the majority of the overall gain in the S&P 500, the performance of the DAX can be attributed to a small subset of the 40 companies that comprise the index.
While automakers have seen share prices collapse between 30% and 73% from their highs, technology-focused companies such as SAP have benefited from the AI boom and have experienced massive growth in revenues and earnings. Shares of SAP, which has just under a 13% weight in the DAX, have risen 44% year-to-date.
Other large-cap companies are contributing to the performance of the DAX. Shares of Deutsche Telekom, the second largest company in the index, are up 23.25% so far this year, and Siemens Energy, a global powerhouse in engineering and technology and the third largest stock in the index, is up a staggering 143%.
Mid-Cap stocks in Germany have lagged large-caps
Bloomberg LP; Garth Friesen
A look at the performance of German mid-sized and small-cap stocks tells a different story. The MDAX index, which tracks a basket of 50 mid-cap German companies, and the SDAX index, which contains 70 small-cap firms, are a better reflection of the weak domestic economy. The MDAX is down 5.00% this year, and the SDAX has fallen 1.75%, underperforming the rest of Europe.
Small and medium-sized companies in the SDAX and MDAX are more sensitive to the local German economy. SDAX companies generate 50% of their revenue inside Germany, and MDAX constituents get 33% of their sales from the domestic market. On the other hand, companies in the DAX get just 18% of sales from German sources.
In addition, similar to the situation in the U.S. with companies in the Russell 2000 small-cap index, smaller firms in Germany have lower profit margins. They are typically more leveraged, making them more vulnerable to the rise in interest rates over the last two years.
Investors shouldn’t look to the DAX as a metric for the health of corporate Germany. The DAX is similar to the U.S. in that a narrow set of companies are responsible for the majority of index returns and earnings-per-share growth. Its strength is driven by the same global themes powering most stock markets- AI, renewable energy, and technology.
The strength of the DAX isn’t due to the German economy but rather a few companies benefiting from global trends. Small and medium-sized firms, as well as large-cap companies reliant on domestic revenue, are struggling. The MDAX and SDAX are better forward-looking indicators of where the German economy is heading. At the moment, these indexes indicate more economic pain is ahead.
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