Germany is building a comeback as US market falters
‘The US stock market has become a play on the digital economy, dominated by a handful of companies’
Betting against the tech-fuelled US stock market has been such a bad idea for so long now that it is hard to accept that its pre-eminence might not be a rule of nature.
What if investors should lift their gaze from Wall Street? And what if they should start to look at a region long written off as a low-growth, ageing, bureaucratic basket case? Is it time for Germany to pick up the stock market baton?
Looking at the recent performance of Frankfurt’s Dax 30 index and that of the S&P 500, there’s nothing to choose between the German and US benchmarks. Since the beginning of the year, the two markets have moved in lock step and both are close to where they started 2020.
Zoom in a bit further and the Dax is actually starting to pull away. It has risen 13pc since the beginning of June, around twice the S&P’s gain over the same period.
The UK and Japanese markets have, by the way, both moved sideways over those two months.
In part, this simply reflects the differing pandemic experiences in Germany and the US. Germany has faced exactly the same challenge as other countries – its 183,000 infections by the beginning of June ranked it ninth in the world.
But its death rate, at around 100 per million of population, has been a fraction of that in other European countries.
Despite one of the region’s leastdraconian lockdowns, Germany was able to declare the outbreak under control within six weeks of its first death. By contrast, America remains in the grip of the pandemic, with one in four of the world’s total infections and more than a fifth of deaths.
The rapid emergence from the Covid-19 crisis is showing up in Germany’s economic data, with last week’s purchasing managers’ indices for services and manufacturing both significantly better than expected. By contrast, the recovery in America’s famously flexible jobs market ground to a halt last week, with the first weekly rise in unemployment benefit claims for four months just days before a $600-a-week (£469) lifeline for the jobless is due to expire.
The improvement in the German economy is starting to be reflected in the more cyclical parts of the stock market, which have significantly lagged the defensive firms favoured by investors in recent years.
Consumer industries such as retail, which are dependent on a healthy economic backdrop, are an important contributor to the Dax’s performance.
They account for 17pc of the market, ahead of the 14pc the same industries represent in the US.
And while technology has been a key driver of the US market, Germany is no slouch on this front either.
Tech stocks such as SAP account for 16pc of Germany’s market, more than twice the proportion in Europe as a whole. Germany’s advantage is helped by a relatively small weighting in the underperforming oil and gas industry, which has been hammered by a crude price slump.
Last week, there was another key political development, with the agreement – after a typical series of all-night table-thumping sessions – of a €750bn (£683bn) recovery fund for the region. This was a hugely symbolic development, a step towards the fiscal integration that most people agree has been the missing ingredient from the eurozone project. What analysts take as tentative signs of political harmony in Europe are a stark contrast to the rancour in Washington that will only deepen as we head towards November’s presidential election.
The impact is being felt in the relative fortunes of the euro and dollar, with strategists at Goldman Sachs now forecasting a rise in the euro currency to $1.25 over the next 12 months – a 17pc increase from its low point in March.
The strength of the euro is a two-edged sword, of course, with a stronger currency making European exports more expensive. But the same analysts at Goldman believe that company earnings in Europe are more sensitive to changes in economic activity than what’s happening in the foreign exchange market. A rising euro also makes European assets more attractive to overseas investors, which will help to overcome the resistance to investing in Europe since the sovereign debt crisis of nearly a decade ago.
One of the main arguments against investing in Europe has been the belief that the star companies of the new digital economy are largely to be found in the US and China.
There is some evidence to support this. Internet companies account for 22pc of Asian stock markets outside Japan and just 6pc in Europe.
It’s also the case that 40pc of companies in the S&P 500 can boast a consistent return on capital employed of more than 15pc versus just a quarter of European businesses.
But it is also arguable that this is a backward-looking measure that doesn’t take account of Europe’s lead in the “green” technologies that might dominate the next few decades as the region commits to zero carbon emissions by 2050.
We should not be blind to the ongoing risks of investing in Germany, and Europe more generally. The region continues to suffer from a range of structural problems. Its labour market is slower to adjust to changing circumstances than America’s; low inflation and consequently low bond yields are a millstone around the neck of Europe’s banks; the population trends in Europe are still unfavourable; and valuations are cheaper than those in the US, but not massively so.
But the recent underperformance of Nasdaq and the technology constituents in the S&P 500 index are a worrying straw in the wind.
It reminds us that the US stock market has increasingly become a play on the digital economy, dominated by a handful of highly priced companies that are vulnerable to a less favourable regulatory environment after November if the Democrats take the White House. Europe, and Germany in particular, is marching to a different beat and could provide some useful diversification in this US election year.
Angela Merkel, the German chancellor, discusses a post-virus rescue plan with other EU leaders in Brussels