In the throes of a pivotal federal election, Germany’s equity market is defying gravity, soaring to unprecedented heights against a backdrop of economic stagnation. The Morningstar Germany Index has clocked an impressive 14% gain this year, leaving European peers and the U.S. market in its wake. But what’s fueling this rally, and can it persist amidst the economic headwinds?
At the heart of the surge is a mix of political anticipation, robust corporate earnings, and geopolitical optimism. Investors are betting big on the upcoming elections, with Friedrich Merz and his Christian Democratic Union (CDU) party leading the polls. The hope is that a swift coalition formation will catalyze reforms, notably a loosening of the “debt brake”—a constitutional law limiting the federal structural deficit to 0.35% of GDP. Carsten Roemheld, capital market strategist at Fidelity, encapsulates the market sentiment: “The market is currently pricing the best possible outcome of the elections.”
Loosening the debt brake, however, is easier said than done. Amending the constitutional law requires a two-thirds majority in both parliamentary chambers, a challenging threshold given Germany’s fragmented political landscape. Holger Schmieding, chief economist at Berenberg, underscores the complexity: “Without a loosening of Germany’s fiscal straitjacket enshrined in the constitution, Merz would find it difficult to convince his potential center-left coalition partner(s) to agree to serious pro-growth reforms.”
The potential relaxation of the debt brake could unleash a wave of government spending on infrastructure, defense, and digitalization. This fiscal stimulus would be a boon for sectors like construction, technology, and finance, driving economic growth and bolstering the equity market. However, the political maneuvering required to achieve this is fraught with uncertainty.
Germany’s stock rally is all the more remarkable given the country’s economic malaise. The nation has been grappling with recession, supply chain disruptions, energy crises, and geopolitical tensions. Yet, the market’s resilience is underpinned by its heavyweight industrial and tech firms, which are well-positioned in the global investment landscape. The relative undervaluation of European stocks compared to the U.S. market has also bolstered their appeal.
Sören Hettler, head of investment strategy at DZ Research, highlights the global reach of German DAX 40 companies: “German DAX 40 companies generate 80% of their revenues outside of Germany, and around 24% in the US.” This global footprint has insulated the market from domestic economic woes, with analysts at German bank Deka attributing the local stock market’s performance to a robust global economy.
The European Central Bank’s monetary policy is also providing tailwinds. With the ECB expected to continue lowering key interest rates, the widening spread between rates in the eurozone and the U.S. could further buoy European equities.
Driving the rally are powerhouse stocks like SAP, Siemens, and Deutsche Telekom. SAP’s meteoric 70% stock value surge over the past 12 months has been a significant contributor to the Morningstar Germany Index’s gains. Siemens and Deutsche Telekom have also seen substantial gains, driven by strong corporate earnings and strategic growth initiatives.
However, the rally comes with a cautionary note. Many of these high-flying stocks are now trading in overvalued territory, raising questions about sustainability. Michael Field, European market strategist at Morningstar, offers a balanced perspective: “Having performed strongly in 2024, German equities now screen as fairly valued… But, while they are not on the whole cheap currently, neither are they expensive.”
For value-conscious investors, the auto sector presents attractive opportunities. Germany’s auto production has been hampered by poor government policies, but the upcoming elections offer a glimmer of hope. Rella Suskin, Morningstar equity analyst, warns that without a focused strategic framework promoting cost-competitiveness, original equipment manufacturers may continue to direct investments overseas.
Domestic politics matter more to small- and mid-caps, which are more directly exposed to the German economy. Their performance has been mixed, with some benefiting from digitalization trends while others grapple with economic stagn
