Analysing the DAX in Germany’s economy

The link between a country’s economic health and the behaviour of its stock index, specifically the performance of the index during periods of decreasing economic growth has always been an intriguing topic. Accordingly, the aim of this article is to illustrate the role of the DAX in the German economy and how the index moved in comparison to the country’s well-being.

Germany has a current GDP of $ 3.95 trillion as measured by nominal gross domestic product. Being the World’s fourth largest economy, following the US, China and Japan, some say that the country has flourished over the last 12 years. Contrary, to the years before 2008 where the country struggled with modernization costs of Eastern Germany and unemployment rates higher than 10%. Its chancellor Angela Merkel strengthened the country’s economic position by successfully pushing through stimulus efforts and tax cuts in the past decade.  Similarly, the country’s leading index, the DAX, has steadily increased and more than doubled in value since 2008. However, as history has shown, the DAX and Germany’s economy do not seem to be as closely related as one might initially infer. Although the index was pushed down during longer times of recession such as the bust of the bubble in 2002 and suffered during the financial crisis in 2008, German stocks have suggested robust performance during times of smaller recessions. 

 Graph 1: DAX performance during times of recessions since 1990

An analogical development can be analysed when looking at the development of the DAX and the German Economy in 2019. According to Claus Michelsen, head of forecasting and economic policy at the German Institute for Economic Research (DIW Berlin), the country would enter its first official recession in six years, mainly due to a cooling export sector. Although Germany only narrowly avoided that scenario with a minimal GDP growth of 0.1 percent in Q3 of 2019, the DAX performance, shrugged off all bad news and maintained a healthy growth development. As results in the following graphs show, while Germany’s GDP has shown signs of weakness over the last 2 years as growth rates turned negative in July 2019, the country’s most valuable companies have continued to exhibit extremely low volatility and a constant growth rate of 17.58% in 2019.   

    Graph 1: DAX performance since 2017    

Graph 2:  German GDP Growth Rate quarterly since 2017

Global political uncertainty affects German exports

Heavily relying on international trade, Germany is the world’s third-largest exporter, led by sales of the automotive industry, machinery, chemicals and electronics. In 2018, the country shipped $1.557 trillion worth of goods around the globe, which reflected a 7.4% gain from 2017 to 2018. However, as of September 3, 2019, the Federal Republic only exported $752.7 billion worth of goods in the first 6 months of 2019, dropping -6.1% compared to the same period one year earlier. 

This is a clear indicator that at the centre of Germany’s latest economic cooling is the struggling export sector. It has been mainly hurt by a slowdown in China due to consistent concerns over a prolonged trade war. Despite the fact that President Donald Trump and Chinese leader Xi Jinping have entered a “Phase 1” agreement based on “mutual respect and equality”, many economists argue that several further steps need to be taken in order to ensure a sustainable global relief. Additionally, the US hit Germany more directly by imposing record tariffs on the EU of $7.5 billion in response to its subsidies for European aircraft maker Airbus.  A second factor that negatively influenced Germany’s export rates is the UK’s exit from the European Union. As the general election in December has helped Boris Johnson to gain a needed majority in the House, the Conservatives are set to finalize their departure. 

On top of that, a sharp decline in the car industry, which has been disrupted by new emissions rules and the shift to electric vehicles, has further put the German economy under stress. Only due to a surprising rebound, as German exports rose to 4.6% in September, Germany avoided a technical recession. As a revive in trade to other EU countries, the UK and US offset a decline in China and provided a boost to the export-focused economy. Carsten Brzeski, economist for Germany at ING admitted that “today’s trade date leaves analysts somewhat scratching their heads.” (November, 2019) Particularly strong growth in the Netherlands and Belgium, as well as 6.9% increased exports to the US upheaved Germany at the last minute. Nevertheless, GDP figures are still expected to show another shrinkage. 

The DAX and its performance in 2019

The DAX, which was created in 1988 with a starting value of 1000 points consists of the 30 largest German companies by market capitalization (calculated using the XETRA-prices). The companies are traded on the Frankfurt Stock Exchange and have different legal requirements to fulfil in order to enter the German index. As one can see in Graph 1, the DAX has increased by around 26,02% from 10.580,19 points on January 2nd, 2019 to 13.337,11 on December 27th, 2019. Among the top gainers in 2019 were the usual suspects such as Bayer, Adidas or RWE. The pharmaceutical and production sector withstood the struggling exports and continued to show robust growth throughout the year. However, major automotive companies such as BMW, Daimler or VW were heavily affected by the trade war and the shift to green energy. In fact, almost all transport-related stocks experienced a rough year and had to deal with a negative performance. 

How can the DAX perform well, despite the German economy struggling?

According to an analysis made by STOXX, part of the Deutsche Börse Group, the DAX mostly showed a strong performance during short periods of technical recession in the German economy. An example can be taken from the years of the latest European debt crisis, specifically during the technical recession lasting from Q4 2012 to Q1 of 2013 in Germany (see Graph 3).

Graph 3: German Recessions and corresponding Dax performance (1991-2014)

Therefore, it can be inferred that there are factors other than Germany’s economic situation that influence the DAX. A very basic point that has to be clear, to understand the relationship between Germany`s leading index and its economy, is that the DAX`s performance is based on the stocks of the companies listed in it. Thus, the development depends on the demand and supply of the company’s stocks, which is influenced by the past and present performance of those companies and especially depends on the expectations regarding the future performance of those companies. 

While the past and current health of a business can be analysed using the company’s financial reports; expectations about the future performance are opinions that are influenced by many other factors. We can subdivide these into economic, political, and other factors. Examples of economic factors that influence the DAX could be the forecast for GDP growth in Germany. But also the global GDP growth rate is relevant since over 75% of the DAX companies’ revenue is generated outside of Germany. Political factors could be the outbreak of a war, rising populism or trade tensions. While other factors could- for example- be natural disasters. Along with these factors, the amount of alternative investments, such as bonds or other asset classes, influence the stock market in a way that, for example, investment opportunities with a better risk/return ratio incentivise investors to pull capital out of the equity market and rebalance their portfolios. Next to future expectations and its influencing factors, there are also psychological and behavioral aspects influencing the stock market, the “irrational exuberance” of investors selling, because “everyone is selling” or buying because “everyone is buying”.

We can conclude that, while the German economy is one of the factors influencing the DAX, if the companies (or at least the majority of the thirty companies) perform well and/or are expected to do so in the future regardless of the macro-economic situation, a positive development of the DAX, even during weaker economic situations is understandable. 

What factors explain the development of the DAX in 2019

In 2019 several major circumstances are widely considered as drivers of the DAX´s good performance. 

Firstly, an economic factor, which also affected the number of alternative investments, are the measures the ECB took to stimulate the European Economy. One concrete example was the ECB ́s deposit facility rate reduction from -0.40% to -0.50% in September 2019. With this measure, the European Central Bank aims to stimulate commercial banks to enhance more borrowings by decreasing their willingness to lend their money to the Central Bank. Hoping to stimulate consumption and investment behaviour of individuals and companies and thereby, boost the economy. This can be considered a reason for the German stock index`s great performance, as individuals and companies may well to prefer to invest their money (or consume) than to save it on their bank account, where inflation and negative interest rates decrease their fortune. Additionally, the ECB reintroduced its Quantitative Easing programme (open-ended government bond-buying of 20 billion euros monthly) starting from November 2019, which can lead to a price-increase of government-bonds bought by the ECB and lower their yields. Consequently, the equity market becomes a more attractive market to invest in. Moreover, Q.E. also lead to increased money supply in the European market, which again enables cheaper lending for banks and improves borrowing interest rates for companies and individuals. To summarize, the ECB contributed to the DAX`s robust growth in 2019 with its low interest rates and its Quantitative Easing programme in three main ways: It made saving unattractive, it made government bonds more expensive, lowering their yield and enabled more investments and consumption since the borrowing of money become “cheaper”.

Secondly, some analysts consider the increase in stock buybacks of companies listed in the DAX as a pillar for the DAX.  Stock buybacks (or share repurchases) are considered an alternative to dividends, especially in the US. One effect of stock buybacks is an increase in earnings per share (assuming profit stays the same) and the return on equity since fewer shares are outstanding. This can make a stock appear more attractive and by that also lead to further purchases, increasing the stock’s price. Although there are no specific numbers released for all share repurchases of DAX companies in 2019, the trend also seems to be increasing in Germany: Having reached its maximum since 2008 of around 8,4 billion euros in 2018 (shown in Graph 4, also including equity buybacks in the MDAX) and the year 2019 starting with the announcement of a 6 billion US-Dollar equity buyback in the next two years by the DAX-company Linde plc.

Graph 4: Share buyback volume (DAX and MDAX)

Thirdly, it was often reported throughout the year markets have been positively affected by the investor’s belief and president Trump’s announcements that a “phase one deal” between China and the US will be reached soon. The deal which has been confirmed by officials on Friday, December 13th and was signed on Wednesday, January 15th in the White House by Trump and Liu He, Vice Premier of the People’s Republic. 

Finally, one factor which has had a positive effect on the DAX towards the end of 2019 is, that after two weak quarters in the third quarter of 2019, 17 of the 30 companies have increased their EBIT in comparison to the third quarter of the year 2018. Also, only ten have experienced a decrease, despite the German economy just narrowly avoiding a recession. In total, the 30 companies listed in the DAX can show an increase in their EBIT of 3,5% in Q3 19, compared to the same period of the previous year. 

Future Outlook

For 2020, Germany’s central bank, the Bundesbank, forecasts a GDP growth of 0,5% in Germany and the Deutsche Bank (DB) predicts the DAX being at 14000 points at the end of 2020. However, there are also economists criticising factors that have influenced the DAX-performance in 2019 and claiming that these factors contribute to the DAX being overvalued. For example, Professor Jürgen Stark, a German economist who was a member of the Executive Board of the European Central Bank from 2006 to 2012, claims that the ECB measures lead to “bubbles” in the stock, real estate and bond markets. As a result, he fears that there will be a correction in these prices at some point in the future. Additionally, Prof. Stark states that the highest global debt-load in peace times is also at least partially caused by the ECB measures.

Next to ECB ́s negative base rate and its Quantitative Easing programme, also the stock buybacks are not free from discussion. Some experts argue that they are used to improve financial ratios (that are often linked to managers numeration), making the stock seem like a better investment and consequently lead to an artificial rise in the stocks price. Also, the claim that there are superior investment opportunities for companies, for instance investing in machines or research, that will generate more sustainable value for shareholders in the future than share repurchases remains persistent.

In a final conclusion, it can be said that the economic situation in Germany only partly influences the Dax, especially during “short” technical recessions a simultaneous increase in the DAX is possible. Therefore, considering the factors listed above, it is not a surprise that the DAX was able to perform well in 2019. Nevertheless, some long-term effects of certain measures taken in 2019 by the ECB cannot be predicted adequately just yet and will remain open to discussion in the future. 

Authors: Constantin Caspar, Karl-Friedrich Flick



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