German Locomotive Losing Steam

Recent economic news from Germany, which has the largest economy in Europe and is considered the “locomotive” for the Eurozone, has not been good. Factory orders in June declined 3.3% from the May level and 2.4% from a year earlier. This followed a 1.6% drop in May. The Purchasing Managers’ Index for manufacturing has been flat for three months. Industrial production registered an advance of only 0.3% over the May rate, following declines in the previous three months. Retail sales and car sales were weak in April and May. The German 10-year Bund yield has declined to a record low yield of 1.06%.

German GDP growth probably ground to a halt in the second quarter – and may have actually declined – following a quarterly gain of 0.8% in the first quarter. While some pickup is likely in the coming months, growth in 2014 is likely to fall below the previously expected 2.0%. In the medium term, growth should ease to the rate corresponding to full employment, about +1.5% per annum due to a declining labor force. Nevertheless, the German economy will likely grow faster than its Eurozone neighbors. Eurozone growth this year is likely to be only about 1.1%.

The tensions between Ukraine and Russia have affected business confidence, with the latest round of sanctions and countersanctions adding to the perceived risks for trade. All Europe has been affected by these tensions, as well as by the stalling of the German economy. The Italian economy, for example, now appears to be slipping into recession. The French economy also has failed to establish sustainable growth. While the Spanish economy is seen as having been transformed by its structural reforms, industrial production in Spain fell by 0.8% month-to-month in June, following a 0.6% drop in May. The euro has slipped to a nine-month low.

German equities have underperformed this year. The iShares MSCI Germany ETF, EWG, declined 9.82% over the past four weeks and is down 11.8% year-to-date, substantially below the year-to-date 7.47% decline in the iShares MSCI EMU ETF, EZU, which covers all the equity markets in the European Monetary Union. In our International and Global portfolios we decided in July to close our Germany-specific positions, which we had held since January of 2012.

The fundamental and technical factors for German equities do not appear attractive now in comparison with some other markets. In Europe, the UK economy continues to outperform, with growth this year likely to be better than 3%, higher than that of any other G7 country. We also have positions in the equity markets of Spain, Norway, and Belgium.

One factor negatively affecting US dollar returns from equity markets in the Eurozone has been a decline in euro–US$ exchange rate. It is now at a nine-month low. We are maintaining a position in the WisdomTree Europe Hedged Equity Fund ETF, HEDJ. It includes a hedge against changes in the euro–US$ rate. It also favors European firms paying higher dividends. This ETF is down only 2.78% year-to-date, far less than the 7.47% decline for the EZU Eurozone ETF cited above.

About Bill Witherell 24 Articles

Affiliation: Cumberland Advisors

William Witherell joined Cumberland Advisors as Chief Global Economist in November 2005 and became a Portfolio Manager in December 2005. He is also a Senior Consultant for Finance and Corporate Governance to the Organization for Economic Cooperation and Development (OECD). From 1989 through September 2005, he was OECD’s Director for Financial and Enterprise Affairs. He joined the Secretariat of the OECD in Paris, France, in 1977.

Dr. Witherell is a graduate of Colby College and holds M.A. and Ph.D. degrees in economics from Princeton University. Dr. Witherell began his career as a business economist with Exxon and Esso Eastern, from 1967 to 1973, where he held positions in the economics, treasury, and corporate planning functions. He moved to the international economic and financial relations field in 1973, with positions first in the U.S. Department of State and then in the Department of the Treasury, from 1974 to 1977, as Director of the Office of Financial Resources and Energy Finance.

Dr. Witherell currently resides in North Grafton, Massachusetts. He is a past Chairman of the International Roundtable of the National Association for Business Economics, and a member of the Boston Economic Club and the Westborough, MA Rotary Club.

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