The German Dax index reached an intraday all time high on January 21, but the broader MSCI Germany peaked in 2000 and did not even reach its 2007 peak yet. Could it be that this recent record for the Dax and 2000 record for the MSCI Germany will last for several decades? If you would ask analysts and strategists the answer almost unanimously would be no, as the consensus is for higher prices this year and the years after. The German economy is after all "the engine" of Europe.
But how realistic is this really? The German economy developed from the "sick man" of Europe in the nineties into the economic engine of the Eurozone in the last six years or so. The Germans did not experience a housing bubble and therefore did not suffer from the downfall of the housing markets like most European countries. On the other and they profited from the fast growth in China and the introduction of the Euro.
Therefore it's not the private consumption that's driving the German economy, it's exports. Germany is an export powerhouse, just like Japan (used to be). Germany benefited greatly from the boom in China and the rest of Southeast Asia. German cars were in high demand in the last several years. The fast growing middle classes and newly rich in places like Beijing, Shanghai, Guangzhou, Shenzhen, Hanoi, Jakarta and Manilla stood in line to buy their Volkswagens, BMW's, Mercedes' and Porsches. Besides that, the fast growing manufacturing industry in China was a happy buyer of the high quality machinery the Germans had on offer.
Dark clouds gathering
But with a Chinese economy that's past its double digit growth rates and in serious trouble because of the gigantic debt problem it has created, the Germans could have a problem as well. The build up of the Chinese manufacturing industry required a lot of new machinery, but this will slow down very seriously in the next couple of years. The Chinese created large overcapacity in many industries with lots of debt. The transition to a more consumer oriented economy in China will come with much lower economic growth numbers.
Another factor is the Japanese strategy of devaluing the Yen and so becoming more competitive. The Japanese compete mostly with the Germans! And this will also hurt Germany's export.
German demographics will be a drag on consumer spending and stock prices
But what about the German consumer? They did not suffer from the collapse of a housing bubble. Can't they fill the gap that will arise from the slow down in exports? Well, don't count on it I would say. I believe the Japanese "lost" decades are mainly the result of demographics.
Arnott and Chaves show in their 2012 study "Demographic Changes, Financial Markets, and the Economy", that not only there is a significant relationship between demographics and GDP growth,but also between demographics and stock prices. Based on their research Arnott and Chaves "forecast" an annual 2% negative abnormal effect on stock prices in Germany in the period 2011-2020. This is by the way much worse in Japan, where the annual headwind for stock returns is about 10%. For the US Arnott and Chaves "forecast" an annual tailwind of about 1,5%.
The rapidly ageing Japanese population causes a deflationary trend and is a drag on consumer spending. The age group of 40- 49 year olds are the drivers of consumer spending. As long as this group is large and growing, consumer spending should be doing well and deflation is not really a threat. In Japan this group topped in 1992, just after the stock market crashed, and shrank by as much as 21% in the years till 2007! Since then it's growing again, till it will start contracting again from 2018.
The Germans on the other hand saw the 40-49 year olds growing up to 2009. Since then it shrank by almost 8%. No wonder consumer spending in Germany is not really taking off despite the favourable economic developments in recent years. But he worst has yet to come. From now till 2023 this group of spenders will shrink by another 26,5%! By 2023 this group will be 32,4% smaller than in 2009! This contraction is much worse than what Japan experienced in her lost decades. By the way, total German population is already shrinking since 2005, while the Japanese population only started shrinking since 2009.
The rapidly shrinking German consumer base
Source: US Census International Database, Global Demographics
Demographics are not the only risk to consumer spending and GDP
German demographics are horrible and we already mentioned a slowdown or even a crash in Chinese GDP growth as a significant risk for Germany, but we did not even mention the risks of failure regarding the Euro project. In case the Euro will fail and Germany would go back to the Mark or to a kind of Neuro together with the stronger Eurozone countries, they will probably have to deal with a much stronger currency. Or if the Euro will keep existing there will be massive future payments from Germany to the weaker countries, which will also not help consumer sentiment and spending in Germany. And what about the enormous unfunded pension liabilities?
All in all the German economy seems to be heading for a Japanese future and it should not be a surprise if the DAX index and the MSCI Germany will have, or already had their peaks in 2014. A way to profit from this shift in German stocks is to short the "Ishares MSCI Germany ETF (NYSEARCA:EWG)"