Risky Business

DAX running out of steam

DAX reuters_distort
Germany's blue-chip DAX can only go up for so long.
  • Why it matters

    Why it matters

    Stock highs built on cheap money carry hidden risks of worse trouble ahead for the global economy, the author warns.

  • Facts

    Facts

    • Germany’s export-oriented economy feels the effects more than most of problems in other markets around the world.
    • The parallel fall in the value of currencies and raw materials in Europe is giving rise to fresh worries about deflation.
    • Stock prices of U.S. companies listed on the Dow Jones Index are already higher than those of German companies.
  • Audio

    Audio

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The British economist John Maynard Keynes once said there were three things that drive people crazy in this world – love, jealousy and stock prices.

Anyone looking at the frenetic ups and downs in the markets recently might have been reminded of that saying.

First, the gamble over Greece was at the root of fluctuations in the German stock index. Now it’s the fear of a downturn in China that is causing adrenaline rushes on the exchange. 

These fluctuations are, above all, an alarm call. The six-year-long boom on world stock markets, driven by an unprecedented flood of cheap money worldwide, has been accompanied by a buildup of risk. The air has also become thinner for export-dependent German companies in the global markets.  

China is not the only risk factor – just the most visible. It is true that the country showed incredible economic resistance and stamina coming through the global financial crisis in 2008. But its economy is gradually running out of steam.

The “Middle Kingdom” is suffering the initial symptoms of three debt-fueled bubbles: an overheated investment climate in industry, a real estate boom and a spectacular upturn in equity markets.

Many other emerging markets are also struggling with big problems, brought on by the fall in prices for raw materials, and the flight of capital into the dollar area.

All of it is a burden for Germany’s export-oriented economy – and therefore its stock prices.  

It happened 15 years ago with the dot-coms and eight years ago with mortgage securities. This time the problem is central banks.

Emerging markets have become the most important growth driver for many industrial companies in Germany. As those economies weaken, so does their demand for imports. Companies with no local production, or only on a small scale, will also lose competitiveness due to the fall in exchange rates.

Also, stock prices for big German companies on the blue-chip DAX index have already climbed ahead of their corporate profits in the last 12 months. So investors will hardly be able to ignore the additional earnings brake being caused by turbulence in emerging markets.

At the same time, the parallel fall in the value of currencies and raw materials in Europe is giving rise to fresh worries about deflation. Until a much hoped-for increase in inflation occurs, we will see neither a tangible boost for growth nor a reduction of the enormous debt burden of European countries.

It is a very different situation in the United States. The economy there is profiting from a flight of capital into the dollar. The stock prices of companies on the Dow Jones Index are already higher than those of German companies. But there is a big chance that this price difference will grow in both the short and mid-term, thanks to the China crisis.

Worse still are the hidden risks that have accrued in this era of monetary-policy alchemy. The biggest risk is in the credit markets – the most dangerous source of financial crises.

Nearly 10 years without a rise in interest rates have all but wiped out the risk awareness of investors. Junk bonds, loans in currencies of emerging markets, industrial real estate and car loans in the United States, as well as government bonds in Europe – it all adds up to much too much cheap money in the credit markets.

But just like before every big financial crisis, apologists use the standard argument of an eternal upswing: This time it’s different!  

It happened 15 years ago with the dot-coms and eight years ago with mortgage securities. This time the problem is central banks. Their money-printing machines will drive up the stock markets to new heights.

In the short term that might be fine. But the European Central Bank and its equivalents in other regions will eventually reach their limits. This will become apparent at the latest a year or two after the first U.S. interest rate hikes. Many borrowers will then look like the emperor with his new clothes – naked and without the pockets to finance the increased burden of interest.

So is this already the end of the stock market boom? No, it’s still too early. History shows that a bubble doesn’t usually burst until interest rates have risen.

But for German-listed exporters, only a moderate further increase in stock prices can be expected before that happens. And it will not be big enough to justify the great risks of entering the market again.

 

To contact the author: d.schaefer@handelsblatt.com

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