Is the DAX discounting a strong economic recovery?

The latest phase of Germany’s DAX rally, started on 27 October 2023. Since then, it returned 36% (vs. S&P500 +46%). Is it already discounting too much recovery from the stagnation (-0.2% average Real GDP growth since 3Q22) that Germany has lived over the last 2 years?

Three big themes and risks

Analyzing the peaks and troughs in German Industrial Production, if its economy bottomed in December 2023, the rally since the trough is actually below par. The real question is: Did the German economy already bottom, or it is simply no longer collapsing? Stock markets tend to anticipate economic and monetary cycles. There are three big themes that over the next 3-6 months create substantial uncertainty: 1) Parliamentary elections on 23 February 2025 and the subsequent Fiscal policy decision of the new government that may raise the (minuscule) debt break of 0.35%, 2) New U.S. administration tariffs, 3) A potential resolution of the Ukraine-Russia conflict.

1)??????? The Government fell very recently (on 7 November), yet the curve bull-flattened 10 basis points. Hence the fiscal expansion idea has yet to be discounted by the DAX.

2)??????? Since the re-election of President Donald Trump, there has been widespread speculation on the extent of Tariffs on Europe. The Euro/USD fall by 4% seems to indicate that Europe will suffer the hit through exports, growth and rate cuts will have to continue. So, Tariffs do not seem to be discounted by stocks either.

3)??????? Ceteris Paribus, the most imminent of the three themes might well be an end of the Ukraine-Russia war, that would most likely generate strong manufacturing orders and service contract as well as may cause a drop in Gas prices, a drop in inflation and further rate cuts.

Conclusion

While the German stocks’ rally continues unabated, several domestic and international events are likely to affect their performance. Based on past economic cycles, the DAX is already discounting a future recovery. If the combination of a geopolitical boost and fiscal expansion produces a positive shock, S&P500 notwithstanding, German equities have more upside. Fixed income might instead struggle to shake-off expectations of higher growth and hence a bottom in inflation. At a negative real rate of -0.15% (2% nominal), 10-year Bunds suffer from the competition of US Treasuries (+2% real). Then the “Real” competition will depend on relative fiscal responsibility….

Ruggero De Rossi (*)

(*) The analysis carried out and the views expressed in this note are personal and do not reflect in any way the official ones of the U.S. Department of The Treasury.

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