Chinese demand will keep the German engine roaring

GERMANY certainly is the engine of Europe at the moment; it has powered its way out of the recession. Exports are booming, unemployment is expected to fall to levels last seen in the early 1990s and its current account is firmly in surplus. The blue-chip Dax index is the model of this good health, outperforming other major indices and offering a year-to-date return of 10.3 per cent. Economy minister Rainer Brüderle boasts that this is its “XL upswing”. Fantastic you might say, but could it be too good to be true? Can there be any upside left? 

Analysts definitely think there is potential for a run higher. When Michael Lippa of the German branch of IG Markets was asked, he said with utmost optimism: “Absolutely. The Dax will hit 7,000 by the end of the year.” Even when some over-exuberance is factored in, there is still plenty to be enthusiastic about. Apart from the financial sector, the Dax’s 30 components have low levels of debt, giving them an advantage over their competitors. But far more significantly, Germany’s status as a net exporter stands the economy in good stead in these troubled economic times.

But perhaps the best thing about the German situation is that China is one of its largest customers – a country that is also in the money at the moment. Morgan Stanley’s recent China Files report identified a whole host of Dax-listed companies that it feels are in a great position to expand in China. For instance, China is now the third largest market for BMW and contributes more than 25 per cent to global profits since the Chinese consumers buy bigger cars – a very profitable trend. The growth prospects for the car market in China are phenomenal when you consider that only around 30 in every 1,000 people own a car and that owning one is becoming a serious status symbol.

The report also tips companies such as Adidas that have the ability to establish franchise and brand-building opportunities in China. Lippa is equally enthusiastic about Siemens’s potential in the Far East.

But Michael Hewson of CMC Markets offers a word of caution: “As strange as it is to say, Germany could do with another sovereign debt crisis in the periphery. The euro is grossly overvalued and this will start to affect other countries’ ability to pay for German goods.” Lippa concedes this is a problem but feels that German export expansion into India and China will compensate for this.

To be on the safe side, should traders ditch the Dax and instead take a position on one of the companies with heavy exposure to Chinese growth?

Perhaps, seems to be the consensus. The index’s financial players are still struggling from the crisis. Not to mention Deutsche Bank’s recent acquisition of the International Securities Exchange in New York for €2bn. A foolish move, according to Lippa.

That aside, there is still good cause to be confident in the Dax. Despite its rapid climb in the third quarter there is little reason to think that it has run out of steam. The upside could be a little muted in comparison to the last quarter, but it is still on track for further gains.