What a year for the German stock market: From a new high of 12,400 to a plunge down to 9,300 in September, equivalent to 25% from its all-time high, to then see the main German index regain momentum in the last few months of 2015 and rise back up to over 11,000 again, thanks to high expectations regarding a dovish ECB. It was evident that expectations were put too high for the ECB and on 3 December it only delivered a small bundle of measures, instead of a large package of additional stimulus.
Worse than the disappointing reaction itself is the loss of trust in the ECB. The next time Mario Draghi tries to talk the EUR down, market players are likely to be much more cautious. And this may also put a floor under the EUR, which bounced off the 1,052-USD-level, and hence stopped further EUR deprecation. The lower EUR against the USD helped drive the DAX to outperform the US indices in spring 2015 and pushed it to its all-time high of 12,400. With a floor under the EUR, higher outperformance potential, which we would have seen with a EUR at parity against the USD, is now out of the picture.
Nevertheless, the DAX still has potential to test the area around 11,800 in Q1 2016 again, as the main drivers for the DAX continue to be the global low yield environment and the cheap Euro, which is bolstering German exporters on the world markets. As the divergence of monetary policy in the US and Europe stays in place, the Euro may continue to border on the upside. The Eurozone area is also showing signs of robust development, which was also highlighted at the ECB’s December meeting, where it raised the expectation for Eurozone growth. In the end, it might have been best to keep its stimulus powder dry, for it to still have measures left to stabilise markets if required. Markets may also slowly start to regain their trust in the Eurozone economic recovery. Another factor to consider is, wasn't the Fed’s confidence in the US economy also starting to play a role as a bullish argument for US equities?
So far, the economy in Europe itself seems to be showing signs of robustness against the slower dynamic in emerging markets. Germany is more exposed to exports into emerging markets and could well feel the headwind as a result. However, a sustained recovery in Europe and further progress in the US economy could compensate for weakness elsewhere. Regarding the profitability and expected returns of DAX companies, current valuations are leaving room for some upside, with the current DAX price earnings ratio standing at slightly above its average ratio over the past 27 years at 13.3, as compared to a P/E-ration of around 17 for the S&P 500.
One of the big question marks regarding the DAX’s performance at year-end was just how big the effect of Dieselgate might be, as well as concerns about the effects a slowdown in the global economy might have on German exporters. Recent developments suggest that the final costs will not only be sustainable, but that the overall reputational damage will remain limited.
Having highlighted the factors in favour of a higher DAX; let’s now take a look at a special factor that could put the dampeners on a DAX rally (even though the DAX might remain stable anyway). One factor that might increase volatility in the near term could be the influx of immigrants in to Europe and the political problems this will create for the Euro-area. After the Paris-terror attacks, citizens seem to be ever more sceptical about the growing number of refugees from the Middle-East, especially after some of the terrorists in Paris seem to have illicitly entered Europe under the guise of being refugees. Consequently, politicians may want to close their borders, which could cause a raft of other problems. If only a few countries such as Germany bear the load, while others close their borders, tensions inside Europe could flare up significantly. The president of the EU-commission Jean-Claude Juncker used stronger than normal language when he recently suggested that the EUR would be under threat were Schengen to fall. We have already seen reintroductions of border controls in France and other countries and should another terror attack occur, this trend may even become more commonplace. Increased political strains within Europe could potentially put further downward pressure on EUR. The ECB has been trying to bring the value of EUR down through its policies, which stock market participants are happy about as a lower EUR improves the competitiveness of European companies, but pressure due to the fear of a breakup of the Euro is a very different story. In this context the increasing popularity of Euro-sceptic parties like the Front Nationale in France are also demonstrating the growing risks.
Another factor that could weigh on the DAX is an economic slowdown in China and emerging markets, a key area for German exporter’s profits. Interestingly, looking at the DAX, the leading share index may well even work as a hedge and hence even potentially remain attractive. If we take a look back at 2012, when the Euro was on the brink of failing, it was Mario Draghi’s words “whatever it takes” that rescued the single currency. One could be forgiven for forgetting that the German DAX was performing well at that time, as popular thinking was that if the Euro failed, a Northern Euro or return to the Mark (linked to German company shares) could be a valuable currency to hold.
From a chart perspective, the 2011-trendlline of the DAX at currently around 9,800 points is in focus for the downside. Should it be broken, a pullback not only to 9,300, but even into the region of 8,300, might even be a possibility. Looking at historical performance, January and February were not bad months, but March performed best for the DAX, so we may have seasonality on our side here. On the upside, the area around 11,800 represents a tough barrier for the bulls. Here is where we find the measured move from the double bottom of around 9,300. We also have the 78.6% retracement of the downward move. Above that at 11,800 the July-highs might represent the last line of defence for the bears. Should this level be surpassed, all-time highs might come back on to the radar.