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GUEST COMMENT: JP Morgan Private Bank On Europe's Largest Economy

JP Morgan Private Bank

9 June 2016

The following commentary about the state of Germany comes from , provided exclusively to this news service. The views expressed are those of the bank, and not necessarily shared by the editors of this publication; we are, however, very pleased to share these views and invite readers to respond.

Germany is the euro area’s powerhouse, with its economy contributing almost 30 per cent to the region’s gross domestic product. As the world’s third-largest exporter of manufactured goods with an 8 per cent share, German cars, machines, chemical goods, electronics, pharmaceuticals and foods are ubiquitous. As a result, Germany’s economic health is of paramount importance to the euro area’s economy, and its complex economy is creating opportunities and challenges for investors. 


External demand and global growth 
Manufacturing represents 23 per cent of GDP, and the services sector linked to its export market is relatively large (exports have a 37 per cent services content). Germany’s exports have also helped the economy recover since the financial crisis, and the country’s economic cycle is closely correlated with global growth. 

“Trade with other euro area countries accounts for just over a third of Germany’s exports and imports, which means the health of the global economy outside the European Union is important for German businesses,” said Ulrich Von Auer, head of investments for the private bank in Germany. “However, limited exposure to emerging markets means slower growth in those regions has only a minimal impact on its export sector. The boost from the euro’s depreciation may be fading in 2016, but with increasing domestic demand, imports could also rise.” 

Strength in the Mittelstand
The main driver of export strength comes from Germany’s “hidden champions”: the Mittelstand companies. These 3.6 million mostly small- and medium-sized enterprises account for around 36 per cent of total revenues and employ almost 60 per cent of the nation’s workforce. They make up more than 60 per cent of most German service sectors and 80 per cent of turnover in the country’s hotel and restaurant, education and construction sectors.

In contrast, manufacturing, financial services and utilities are predominantly controlled by large businesses. Measured by revenues, the share of small- and medium-sized enterprises in these three sectors is as low as 24 per cent, 19 per cent and 10 per cent, respectively. 

“Investors seeking passive exposure to German equities should consider this varied industry structure, which underlines the importance of choosing the right index,” Von Auer said. “Sector composition can have a significant impact on performance.”

The investment opportunities 
“European equities feature in our portfolios, and in the past we gained exposure to German equities through the MDAX Index rather than the DAX, the country’s main index,” Von Auer said. “However there are significant differences between the two. The DAX has underperformed Europe’s other leading indices over the start of 2016, mostly because of its heavy weight in financials, 19 percent.” 

Given that the DAX has exposure to regulated sectors, such as utilities, global investment banks and global insurance companies, JP Morgan believes the MDAX is a better way to gain exposure to the strength of the domestic consumer. Overall, the MDAX capitalizes on the strength of the German economy and has a particularly attractive mix of aerospace, real estate and consumer discretionary stocks.

Diverging fortunes - a proxy for European equities 
“Our European equity exposure is neutral relative to the benchmark,” Von Auer added. “We would not start differentiating between countries yet, especially while the ECB is in the middle of easing. Until the central bank starts buying investment grade corporate credit and banks begin to take up the new targeted longer-term refinancing operations (TLTROs), we forecast growth in the region at around 1 per cent to 1.5 per cent.”

“In this environment, Germany is well placed for maintaining its trend growth from the past few years. The German stock market is often considered a proxy for European equities, especially by foreign investors,” Von Auer said. “Our perspective is more nuanced and we believe equity selection is key for German stocks. Those that provide exposure to domestic consumers can avoid global risks and offer potential upside to domestic demand.”

Germany’s economic and political climate provides the basis for understanding Europe’s future. Germany has insisted over the past few decades that it wants to help European development from an integrated perspective and not as an individual effort. Similarly, JP Morgan has diversified its European equities exposure throughout the region because we believe the ECB’s efforts are aimed at both the core and periphery, and drive toward a convergence of economic development across the euro area.

Opportunities in German financial assets – across the capital structure, both in equities and corporate credit – should be approached selectively from a bottom-up perspective, especially in an environment where sovereign yields are negative at the longer end of the yield curve.