The gateway to higher German economic growth is in the hands of the German consumer who is by all accounts “conservative”. Polls show that most have very low expectations of prospects for a stronger economy. 61% believe that German’s economic situation will be worse four years from now, and only 16% believe that Chancellor Merkel can sharply decrease the unemployment rate.
Germans know that they need to make some significant changes but are resistant to dismantle the expensive social net and inflexible labor regulations that hamper German growth. The key issue is the former East Germany. Germany has poured $1.5 trillion into the region and unemployment is still about 19%. Instead of taking advantage of its lower wage structure, German unions rushed to unionize East German workers that did not have the necessary skills and training to be competitive at high wage rates.
The brightest spot for Germany has been exports of industrial goods, with especially strong exports to China. But this is changing as China makes more of these capital goods itself. Chinese exports to Germany have risen sharply while German exports to China have been flat. Germans have a high savings rate of 11% of income and GDP growth has averaged less than 1% during the last three years.
So why should investors get excited about EWG?
The first reason is very low expectations. Any improvements, even marginal, will have a positive affect on markets. Secondly, the overall market is not expensive at about 14 times earnings.
Thirdly, the German companies that dominate the holdings of the Germany iShare ETF are world- class multinationals and are more tied to booming Asia than to the slow growth German economy. Large German multinationals are shedding high cost and inflexible German workers. Siemens (SI), Deutsche Telecom (DT), Allianz (AZ), Deutsche Bank (DB), DaimlerChrysler (DCX), Bayer (BAY) and BASF (BF) account for 50% of the holdings of EWG.
Plus, the pace of economic growth and employment numbers in Germany seem to be moving in the right direction. Germany’s DIW economic institute, the largest of the country’s six leading research institutes, today raised its outlook for growth this year to 1.7 percent from 1.4 percent. Gross domestic product may even reach 2.5 percent next year.
The German economy is a huge restructuring play that will take many years to bear fruit, so investors should go with large German multinationals such as ABB (ABB) and Siemens that are not waiting for the politicians to tell them what to do. They are searching the globe for opportunities and winning big contracts and profits for shareholders.
EWG 1-yr chart
Disclosure: Author is long EWG.