Germany – From best in class to problem child, now ray of hope?
By Alexander Dominicus, Portfolio Manager in Mainfirst’s team Blend / European Equities
For decades Germany was regarded as Europe’s star pupil, with a strong industrial sector, innovative technologies and a highly qualified workforce. But it is losing its touch. However, there is a unique opportunity to invest in the German SME sector in the current environment.
The bad news surrounding the German economy are not ending. Once the world’s leading exporter, Germany was unable to achieve any growth in the fourth quarter of 2023. Nor does the outlook on the rest of the year hold out the prospect for the desired impulses for growth.
For decades Germany was regarded as best in class in Europe with a strong industrial sector, innovative technologies and a highly qualified workforce. But the shine is fading, and many companies are complaining of bureaucracy, a skills shortage and a misguided energy policy.
Most issues cannot be resolved overnight, as especially the era of cheap energy is likely to be over for the time being. The power plant strategy recently adopted by political leaders aims to enhance planning reliability. It promotes investment in hydrogen-capable gas power plants to complement the supply from renewable energy. Location of production is increasingly a topic for energy-intensive companies. More and more, companies are investing in new production capacity abroad; in addition, existing factories are under review, with some being closed or gradually being relocated.
While the government has recognised the subject of bureaucracy as a problem area, companies are not seeing tangible progress. That said, the German Bureaucracy Reduction Act IV is one of the initiatives and measures that the traffic light coalition has announced, some of which are already in the process of implementation. For example, this Act aims to speed up approval processes and reduce non-essential duties to provide information.
The skills shortage could worsen, as the baby-boomer generation enters retirement in the coming decade. However, German companies are not unprepared and are working on various possible solutions. In particular, digitalisation provides greater flexibility to deploy employees regardless of location. This results in more and more new jobs being created abroad; for instance in the IT sector. Countries in Eastern Europe in particular are growing locations for German companies. Artificial intelligence can also provide a way to mitigate the shortage of skilled workers. Companies are working at full speed to digitalise manual processes, thereby reducing the required headcount.
SME sector less affected by German energy policy
We should be very careful in writing Germany off. Companies have come through many a crisis and are constantly adapting to the more difficult circumstances. Successful companies expand globally and diversify with new products and services. They thus increasingly look for growth opportunities abroad and drive forward expansion on an ongoing basis; for instance in the US. The equity market clearly shows how significant companies can decouple from a poor domestic economy, with the DAX again reaching a new all-time high despite negative growth in Germany.
However, for investors it is essential to consider the energy issue when selecting stocks. It is primarily the energy-intensive sectors such as chemicals and steel that are most affected by the higher energy costs. Looking at the German SME sector, many companies have less energy-intensive business models and are thus not as strongly affected by German energy policy.
SMEs and family-run companies are often less bureaucratic than large companies. In many cases, they have flat hierarchies and short decision paths. In times of great change, this is an important factor in adapting and staying successful and competitive in the long run.
There is a unique opportunity to invest in the German SME sector in the current environment, as the vast majority of the market has ignored this segment of smaller companies and no longer pays attention to it.
Having underperformed for more than three years, small caps are now trading at historically low prices compared to large caps – and buying good companies cheaply has always been the strategy for investing in the stock market with the greatest long-term success.
