investment insights

    Waiting for Germany

    Waiting for Germany
    Stéphane Monier - Chief Investment Officer<br/> Lombard Odier Private Bank

    Stéphane Monier

    Chief Investment Officer
    Lombard Odier Private Bank

    Key takeaways

    • Germany’s stalling economy needs fiscal stimulus and new leadership
    • The size of Germany’s economy makes it key to the wider EU’s health too
    • Germany has the fiscal room to increase government spending
    • In the current environment, we like European real estate and favour European equities over US equities. After the latest equity market sell-off, we see more potential upside in European stocks.


    After a decade of strong economic growth, Germany has gone from the European Union’s motor to a drag on the bloc’s economic health. The country urgently needs to stimulate its economy, for the good of both Germany and the EU. A domestic political crisis this month is also underlining a lack of leadership and direction at the European level.

    The German economy slowed in 2019, recording an annualised 0.6% growth in Gross Domestic Product, the country’s weakest expansion since 2013 and narrowly avoiding a technical recession. In comparison, the eurozone as a whole expanded 1.2% last year. Germany’s GDP will grow 1.1% “or above” this year according to Eurostat, slightly more than our 2020 eurozone forecast annualised growth of 0.9%.

    Germany is the main trade partner for many of the eurozone’s economies. Any improvement in the German economy would therefore have positive implications for the whole region as it accounted for 28% of eurozone GDP in 2017.

    The country is simultaneously working to end its reliance on traditional energy sources, nuclear by 2023 and coal by 2038, in favour of renewables. Early closures of nuclear and coal plants will cost Germany at least EUR 41 bn. Since these traditional energy sources are located in the south-west of the country, significant investments will be required to bring clean power to these areas. In addition, Germany is implementing a carbon tax to halve its emissions by 2030 and meet its carbon neutrality target by 2050, a plan that could cost as much as EUR 100 bn.

    Germany’s car industry is a good example of the country’s economic challenges. It accounts for around 5% of GDP and more than two-thirds of production is destined for export. However, since mid-2018, German passenger car exports have fallen more than 13%. Last year, the industry produced the fewest vehicles since 1997 as sales in Europe, its biggest market, as well as China, declined. The global economic cycle, a Chinese slowdown, the US/China dispute and stricter European emissions regulations all added to carmakers’ difficulties of anticipating and meeting demand for electric vehicles.

    In addition, the coronavirus outbreak may impact EU economies in general and Germany in particular. China accounts for an average one-sixth of German companies’ sales.

    Spending room

    Political aversion to higher public spending may be shifting...

    While Germany has economic challenges, it also holds the keys to unlock its own growth. It runs the world’s largest current account surplus of as much as 9% of GDP, which, coupled with falling public debt, leaves room to invest in infrastructure projects and cut taxes. The country’s fiscal spending has been rising steadily for the past two decades, but still lags levels seen in the 1990’s following reunification. Along with higher wages, government spending would increase domestic purchasing power and so help counter the economy’s dependence on exports.

    Although Germany’s 2009 constitutional orthodoxy commits it to a balanced budget, political aversion to higher public spending may be shifting as concerns about an overheating economy evaporate. The eurozone’s finance ministers, including Germany’s Olaf Scholz, last week said they are prepared to increase public investments in the event of economic slowdown.

    Succession questions

    Germany is going through a period of political instability with a relatively weak coalition government. In December 2018, Chancellor Angela Merkel stepped down as head of the Christian Democratic Union party, placing protégée Annegret Kramp-Karrenbauer, known as AKK, in the role and making her Mrs Merkel’s logical successor as Chancellor at the end of 2021. That transition was wrecked when, on 10 February 2020, AKK resigned as party leader over her handling of the appointment of a regional far-right politician.

    A number of possible candidates are manoeuvring to replace AKK by the summer, including Jens Spahn, the current health minister and Armin Laschat, prime minister of the North Rhine-Westphalian region. A third possible replacement, Friedrich Merz, a former CDU parliamentary leader, is seen as a rival to Mrs Merkel. His appointment would be seen as a direct challenge, and may trigger the collapse of an already unstable government coalition with the Social Democratic Party (SPD).

    We have a history of proposals waiting for answers.

    The EU lacks political leadership too. Political weakness in the EU’s biggest economy is coinciding with the UK’s departure from the bloc. Brexit’s consequences include questions over the 2021-27 budget for the remaining 27-member states as they work out a new balance between net contributors and net beneficiaries.

    As well as haggling over future finances, the bloc also needs its founding Franco-German alliance to re-think its strategic ambitions. French President Emmanuel Macron has called for greater European coordination on a series of subjects, including technology, defence and environmental questions. “We have a history of proposals waiting for answers,” he said on 15 February 2020.


    Asset outlook

    Where do these uncertainties leave investors in European assets? The first meeting of European Central Bank policymakers under its new President, Christine Lagarde, kept interest rates on hold. The ECB is now focused on a strategic framework review scheduled for completion by end-2020, and until then, the Bank’s accommodative approach should continue.

    In this context, year-to-date, investors’ risk aversion has supported fixed income. Specifically, the coronavirus outbreak triggered demand for German Bunds. 10-year Bunds are trading at -0.50%, 21 basis points above their lows and the spread between the benchmark German government paper and US Treasury bonds has tightened to levels not seen since early 2018.

    Germany’s cities are recording strong growth in values

    This persistently low-to-negative yield environment means that European real estate offers investors attractive opportunities. We have been gradually increasing our exposure to this asset class since June 2019, including in Swiss investors’ portfolios. Within European real estate, Germany’s cities are recording strong growth in values with rising rents in line with their growing populations and refurbishments. That has triggered political discussion about legislating against further rent increases. We do not believe that this will happen. We therefore favour indirect investments in the market where we expect valuations of listed German residential companies to catch up once the uncertainty disappears.

    Low yields are also offering support for equity valuations. Our equities preference is for European stocks relative to US names. European equities are trading at more attractive absolute and historical valuation levels for 2020 estimates, 14.9 times earnings per share compared with US equities at 19.1 times, in spite of similar EPS growth consensus expectations for this year. After neutralising for the impact of the technology sector, these valuation differences look only marginally lower, with US equity markets trading at 18.8 times. After the recent equity market sell-off, we see more potential upside in European stocks. From a sector point of view, we maintain a balanced exposure between defensive and cyclical sectors and are overweight in healthcare, consumer staples, information technology and communication services. 

    German firms are trading at a discount to their European counterparts because of their greater dependence on global trade, especially exports to China. Based on our expectation of a rebound in China’s economy, and assuming the coronavirus impact is transitory, German equities should therefore catch up with other European markets. 

    On the currency front, the euro/dollar has reacted to weak German manufacturing data and eurozone industrial production. We believe that the currency trajectory will be higher as the coronavirus’ impact should be transitory and global manufacturing picks up, providing a headwind for the dollar more broadly.

    Overall, investors are facing unusual uncertainty over the EU’s biggest economy this year. Germany’s stuttering growth and difficulties of transitioning to new leadership present it with a series of choices at a crossroads in the EU’s history. The decisions that play out in Germany over the coming months will have meaningful consequences for all European assets.

    Important information

    This is a marketing communication issued by Bank Lombard Odier & Co Ltd (hereinafter “Lombard Odier”).
    It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a marketing communication.
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