Global Markets Weekly – 30^th April 2007

Key Macro economic developments

• A record high on the euro exchange rate (against both the dollar and yen) would typically spell big problems for the German economy, but the headline activity figures remain at elevated levels, with the April IFO survey again surprising on the upside on its release last week. Crucially, both the assessment of current conditions and business expectations increased on the month, suggesting the now long-running improvement in sentiment can continue for a few months yet. Estimates of German GDP growth from the country’s influential economic institutes – which had always appeared too low to our mind – have also been revised up sharply. Concerns over the impact of the 3% hike in German VAT rates at the beginning of the year – which had been likened to the ill-fated decision of Japanese policymakers to raise consumption taxes back in 1997, helping to scupper a fledgling economic recovery - also look to have faded into the background. But despite this run of good news from Germany, opinion remains divided over the underlying causes, and therefore sustainability, of the country’s improved economic showing.
• Has the sick man of Europe experienced a Lazarus-style recovery, or have the underlying symptoms merely retreated for a while, only to return at some later date? Optimists, somewhat ironically, will point to the less favourable economic environment presented to German corporations by European Monetary Union (EMU) back in 1999 as the starting point for the current upturn. The ‘one-size fits all’ monetary policy operated by the European Central Bank meant that interest rates would be higher than if set solely on the basis on Germany’s needs, and the EMU entry level of the Deutschemark was also regarded as being uncompetitive (too high). Faced with a changed economic landscape, the German corporate sector had no option but to engage in often painful restructuring, improving underlying competitiveness and building the platform for the current upturn.
• Those of a more sceptical nature, however, would suggest that, while Germany’s hard work of recent years will no doubt have helped, the current pace of growth may owe as much to luck as it does to judgement. German exports have traditionally been concentrated within heavy industry, and the current boom within capital goods demand from emerging economies – China in particular – has left Germany well placed to enjoy a temporary upturn. The problem of weak consumption in Germany has not been cured, and economic malaise, it is argued, will return as external demand moderates, perhaps in response to the euro’s new record high.
• In truth, both arguments have merit. The pace of consumer spending in Germany certainly remains disappointing, even if the steady improvement in the labour market offers hope on this issue. But the sustained acceleration in growth, even as higher interest and exchange rates have combined to tighten monetary conditions, does suggest some underlying improvement, and investors certainly seem to be buying into this optimistic viewpoint.

Key global market developments

• The German stock market continues to power ahead.  Having regained its February highs by the start of April, the DAX index has moved to new highs and is now 12% ahead for the year.  However, the more cyclical German market suffered more in the downturn at the start of the decade, so German equities are still some 7% below their year 2000 peak.  The German market is still attractively valued with an average Price Earnings Ratio at 15 times, close to its ten-year low and below the average for global equity markets.  With a greater focus on shareholder returns, due to improving corporate governance and the increased levels of Mergers & Acquisition activity, Coutts believes that the investment outlook for German equities remains positive.

Indices, Interest rates and Inflation

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