Export-led German economy has been hit hard by crunch

Jul 1 2009 by Andrew Miller , The Journal

IT seems like an eternity since Germany was regarded as the powerhouse of Europe. Indeed, since the end of its post-unification construction boom, Europe’s largest economy has significantly underperformed its continental peers.

Between 1995 and 2005, annual growth averaged just 1.3% compared to 2.1% for the euro area. This weakness was particularly stark in the five years following the bursting of the technology bubble in 2001. The average rate of expansion was just 0.6% – earning Germany the title “sick man of Europe”. Stagnant household spending was the main culprit. Consumers pulled in their horns as the corporate sector slashed wages in what ultimately proved a successful drive to improve Germany’s international competitiveness.

By 2006 the German economy had pulled out of the slow lane. Its large manufacturing sector, now competitive after years of cost cutting, found itself well placed to benefit from the strength of global growth. Booming exports and capital spending enabled the German economy to expand by 2.2% over the 2006-2008 period, slightly ahead of the euro-area average.

More recently, this strength has become a source of weakness. Over the last few quarters, Germany’s export-led economy has been hit hard by the collapse in world trade.

This has led some observers to suggest that the economy is actually in worse shape than in Spain or the UK, which are experiencing the collapse of credit-fuelled housing market booms. Such pessimism about German prospects is short-sighted and ignores future economic fundamentals. These provide a compelling case for further German outperformance over the medium term. Germany’s large capital goods-oriented manufacturing sector will be one of the main beneficiaries of the global economic recovery and the large infrastructure build up in China and India. The higher relative exposure of German exporters to China is particularly striking here.

Moreover, in contrast to the last decade, developments on the domestic economic front are likely to be more favourable. After the financial prudence of recent years, the magnitude of Germany’s discretionary fiscal stimulus will be much larger over the next 18 months than in its euro-area peers. In addition, with zero house price growth over the last 15 years, Germany does not have to deal with the fallout from the collapse of a housing boom, which will put a brake on the performance of many European countries. Lastly, wages have started to move higher since 2006. This should be supportive of future sustainable improvements in consumer spending, when confidence amongst households begins to recover.

The German DAX 30 is of course a more cyclical market than its euro-area peers. So it is likely to outperform as risk appetite gradually improves and equity markets move higher. Moreover, investors should react positively to the economy’s transition from globally-dependent export-driven growth to a less volatile and more domestically-driven economic model. This move towards domestically-driven growth will not, however, impede many German corporations benefiting from large, fast-growing exposure to the high-growth Asia Pacific region.

Companies such as Siemens and Adidas generate more than 20% of their revenues in Asia, for example.

In short, we believe that the re-rating of German equities versus the rest of Europe is likely to continue as the economy outperforms over coming years. But, since we are not expecting the global economy to return to the boom levels seen earlier in the decade, the returns from German equities are likely to be good rather than spectacular.

Andrew Miller is regional office head of Barclays Wealth in Newcastle