2017 saw a dramatic about-turn in sentiment towards Europe. Fears concerning populist politics at the beginning of the year were quashed; first by Emmanuel Macron’s French election victory, and then by market- and EU-friendly votes in the Netherlands and Austria.
But the German election threw up fresh concerns as incumbent Chancellor Angela Merkel won the most votes in October’s election, but not enough to form a government. The far-right AfD won more of the vote than expected, making them the third largest party in the Bundestag.
The spectre of a coalition was not a worrying development per se, due to Merkel’s CDU/CSU party having governed alongside the SDP previously. But the latter’s insistence they would not continue this grand coalition created uncertainty.
Negotiations between Merkel’s party, the Free Democrats and the Greens began on 18 October and ended a month later with no agreement. Shortly after, the SPD indicated they may change their mind.
It was not until early February that the two parties managed to agree a deal. This agreement was finally ratified eight days ago by the SDP’s membership.
Investors Look to German Equities
Investors took heart from the coalition deal, pumping €873 million into exchange traded funds tracking the country’s blue-chip DAX index. This was the highest inflow figure since June 2015 and reversed four consecutive months of net outflows since the election result.
The iShares Core DAX ETF (EXS1) saw €248 million of inflows, followed by the Morningstar Bronze Rated Xtrackers DAX ETF (DBXD) at €221 million and ComStage DAX ETF (C001) with €188 million.
Six of the 30-strong DAX constituents account for half of the index, headlined by software provider SAP, industrial products manufacturer Siemens (SIE), insurer Allianz (ALV), drug maker Bayer (BAYN), chemicals producer Basf (BAS) and car maker Daimler (DAI).
German growth has be running well above its long-run average of just below 1.5% for five years now, according to broker UBS. Economist Felix Huefner expects this to continue, with real GDP of 2.5% and 2% pencilled in for this year and next.
Meanwhile, unemployment has never been lower, house prices are rising strongly, wage growth is slowly picking up and monetary policy remains too loose for Germany, Huefner adds. As a result, many are concerned the economy is about to overheat.
“So Germany easily enjoys the eurozone’s most mature upswing and the ingredients for an eventual overheating are in place,” Huefner continues.
However, while he sees signs of overheating in the construction sector, corporates are still indicating their intention to increase capital expenditure in the future. “Barring a shock, we think the economy has more room to grow before fully fledged overheating eventually sets in.”
Changing of the Guard in Europe?
A question hangs over Germany’s role in Europe however, according to Dale Robertson, co-manager of the Chelverton European Select Fund. While Germany has long been the dominant force on the continent, things could change, Robertson suggests.
Ever since Gerhard Schroder’s premiership, the balance of power has tilted towards Germany, he explains. Schroder’s Agenda 2010 reforms saw the liberalising of Germany’s economy and a lot of power in key industries taken away from unions.
“The German economy has been an outperformer ever since, especially relative to France, where the opposite has happened.” However, now he thinks many of these market-friendly reforms may reverse due to the increased pressure Merkel has come under. “This is at the same time as France appears to have a reformist President.”
He also worries that China could pose a threat to Germany’s manufacturing dominance, as the Asian powerhouse continues its rise to becoming a power on the global stage.
“Taken together, I’m of the view that the balance of power both politically and economically within Europe will at least neutralise somewhat, if not shift completely away from Germany,” concludes Robertson.
Investing in German Equities
Index-tracking ETFs give investors the ability to cheaply participate in a country’s equity markets. However, they capture the broader picture, rather than having the ability to allocate capital to, or away from, specific sectors.
Selectivity will be important if and when the country does experience an overheating economy, according to UBS. Their analysts looked at the three post-reunification periods of economic stress and found that capital goods and semiconductors tended to outperform. Conversely, pharmaceuticals and healthcare stocks underperformed.
As a result, active fund managers may be a more profitable bet during the next period of overheating.
Jupiter European is the fund rated Gold by Morningstar analysts with the largest exposure to Germany. Managed by Alexander Darwall, the offering has around a third of its portfolio invested there.
In the closed-end space, the Jupiter European Opportunities (JEO), also managed by Darwall is rated Gold and has a similar exposure to Germany. Wirecard (WDI) is the largest holding in both funds, with Deutsche Boerse (DB1) and Grenkeleasing (GLJ) in the top 10 of both.
