Germany has seen the worst collateral damage of the US/China trade war. Chancellor Angela Merkel told the Bundestag lower house of parliament last week: “We have international uncertainty due to the US-China trade conflict and that is of course having an impact on an export nation like Germany.”
Declining economic figures had already made that abundantly clear. The most recent industrial output figures showed a decline of 0.6% in July. While this was slower that the 1.1% decline in June, it was a far cry from the 0.3% climb that economists polled by Reuters had expected. Economic research group the Macroeconomic Policy Institute (IMK) now put a near-60% chance on the German economy falling into recession. This is up from 43% in August and the highest level since late 2012.
A Desperate Situation
Azad Zagana, senior European economist and strategist at Schroders, points out that Germany has also has a number of idiosyncratic problems: “The situation is more desperate in Germany, exacerbated by recent unrelated problems including the diesel emissions scandal, and the low levels of the river Rhine – a key shipping route for manufacturers.”
His view is that industrial weakness cannot fail to hurt the consumer eventually: “Official figures suggest employment growth in manufacturing sectors on the whole remains robust, but if the trend in output continues, there will inevitably be lay-offs. Although employment in industrial sectors has been shrinking, in Germany, it still represents just under a fifth of the workforce. Job losses in these sectors would impact household spending.”
The ECB is clearly spooked. In its most recent meeting, it announced plans to cut the deposit rate from -0.4% to a record low of -0.5%. It will also resume its quantitative easing programme, buying €20 billion of bonds every month from November onwards, having taken a pause since December of last year. Mario Draghi blamed “a more protracted weakness of the euro area economy, the persistence of prominent downside risks and muted inflationary pressures.”
The weakness is also being felt in some major German companies. Over the summer, chemicals group BASF (BAS) issued a profits warning, which rattled the country’s industrial sector. It blamed US/China trade tensions, with particular weakness in the car industry, for its woes. Other German flagship companies have been hit: Siemens (SIE) said deteriorating demand from automotive and machine building firms would hurt its third-quarter profit, while industrial giant ThyssenKrupp (TKE) issued its fourth profit warning in August.
Stock Market Impact
However, Germany’s weakness hasn’t yet had a major impact on its stock market. The DAX is up 5.9% over the last six months. That puts it slightly ahead of the S&P 500 over the same period (5.8%) and significantly ahead of the FTSE 100, which is flat. However, it did come after a period of significant weakness for German equities in 2018 as the market anticipated difficulties for some German companies.
This weakness of some of Germany’s strongest companies has prompted some to argue that the problem may be more than just a passing phenomenon. Tim Albrecht, manager of the DWS Deutschland fund, told Bloomberg: “The summer of profit warnings shows that Germany has a structural and not a cyclical problem.” Others have argued that negative interest rates are exacerbating the problem, with too many "zombie" companies propped up by the low cost of borrowing. This, in turn, sustains pricing pressure for the good companies. It is also worth noting that German carmakers could be vulnerable to a no deal Brexit, which would reverberate through the German industrial sector.
Top Performers
That said, many of the best-performing fund managers in the sector still have relatively high weights in Germany. The Jupiter European fund, for example, has around a third of its assets in German equities with significant holdings in companies such as Deutsche Boerse (DB1), Adidas (ADS) and Bayer (BAYN). For reference, the MSCI Europe ex UK index, is around 19%-weighted to Germany.
Outside its industrial sector, Germany is still home to some of the "quality compounders" that have found favour with investors in the current market. As with elsewhere, a company’s consistency of earnings and reliability have proved far more important than its domicile in driving its share price. Greg Herbert, fund manager on the Jupiter European Opportunities (JEO) trust, says that some of these stocks with strong franchises and cash flow have seen gains of more than 40% since the start of the year in what has become "the only game in town". This has helped support the aggregate performance of the German market.
The final question is whether German weakness will spread to other European economies. To date, countries such as Spain and France have posted relatively strong GDP growth figures and this has helped keep the Eurozone above water. The problems within Germany have been largely confined to the industrial sector, which helps limit contagion. This is no 2008/9 scenario, when the German economy saw a painful contraction; nevertheless, it is difficult to see how the German economy can do more than limp along in the near-term.
