After a strong start to 2017, the German blue-chip index – the DAX 30 – fell more recently as a strengthening euro sapped some of the momentum out of markets.
While the German election in September is unlikely to introduce much volatility for the market – as polls elsewhere shrugged off the wave of populist anti-EU sentiment seen across the continent last year – it remains to be seen whether the index will recover from the pull-back that has hit it in recent months.
In local currency terms, the DAX 30 has risen by just 5.09 per cent, year-to-date, lagging other European indices such as the French CAC 40, which has risen by 7.48 per cent, and the FTSE 100, which is up by 5.65 per cent.
Performance of European indices YTD
Source: FE Analytics
John Higgins, chief markets economist at consultancy Capital Economics, said the index had surged during the first half of the year despite the “stark appreciation” of the euro.
He said: “This might seem surprising, since a stronger currency is not only bad news for German exporters, but also reduces the value (in euros) of the earnings of German multinationals’ foreign subsidiaries.
“Nonetheless, the rally in the euro reflected foreign investors’ increased appetite for assets in the eurozone amid greater optimism about the region’s economy.
“Indeed, net foreign purchases of equities were around €230bn in the first six months of 2017, more than in any other half year since the inception of the euro.”
Yet, during the past two months, the index has fallen as euro has continued to climb, according to Higgins.
Indeed, the single currency has risen by 7.22 per cent against sterling and by 12.12 per cent against the US dollar in 2017 (as at 21 August), according to data from FE Analytics.
Strengthening of the currency more recently has likely been fuelled by expectations of tapering by the European Central Bank (ECB), the chief markets economist said, rather than greater optimism around the eurozone economy.
“Indeed, concerns are mounting that excessive strength in the euro will hinder the recovery in Germany and her neighbours,” he said.
“This is reflected in the share prices of German small and medium-sized firms, which have generally held up far better than those of the larger, multinational, firms that dominate the DAX 30.”
Higgins doubted that the recent pull-back was a longer-term trend, with the consultancy forecasting that the US dollar/euro exchange rate will edge back down during the latter half of the year.
The economist said the outlook for monetary policy in the eurozone and the US was likely to see the dollar strengthen against the euro.
He explained: “On the one hand, we think that the ECB will continue to stress that its tapering will be slow and that rate hikes remain a long way off.
“On the other hand, we suspect that the Fed will spring a bit of a surprise by raising rates again in December after starting to normalise its balance sheet this autumn.”
Additionally, Higgins said its outlook for the German economy was positive.
“Although some surveys suggest that the economy has a lost a bit of momentum, they generally indicate that it will continue to perform quite strongly,” he said.
German GDP growth over 3yrs
Source: Eurostat
Higgins said a more optimistic outlook for the broad eurozone economy was also positive for German exports.
Despite its more bullish forecast for German blue-chip stocks, the current level of the DAX 30 had left the index 11 per cent below the consultancy’s previous forecast for the year.
While the index is unlikely to recover that lost 11 per cent before the end of the year, said Higgins, it was factoring in a small gain for 2017 and believes the index will perform better than its US counterpart the S&P 500.
The S&P 500 has risen by 9.46 per cent in US dollar terms this year, outperforming the DAX 30, but Higgins expects German blue chips to outperform US large-caps, adding that it has forecast the index to end the year at 2,400, slightly below its current level.
Performance of S&P 500 vs Dax 30 YTD
Source: FE Analytics
He added: “We think that the prospects for German large-cap equities during the remainder of 2017 are quite bright, despite their pull-back over the past two months.
“Admittedly, we are revising down our end-year forecast for the DAX 30, from 13,500 to 12,750. But our new projection still implies a rebound of 5 per cent between now and the end of the year.”
However, while Higgins is bullish about the prospect for the German it may take some time for that message to get through to fund managers.
Allocations to Germany fell back “materially” during August among European fund managers polled in the Bank of America Merrill Lynch Fund Manager Survey.
A net 7 per cent of European fund managers were overweight German stocks from a net 32 per cent allocation in July.