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Stock market: This is why stock prices are rising even though the economy is slowing down

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Stock market: This is why stock prices are rising even though the economy is slowing down

Bull beats bear. The Dax is rising on the Frankfurt stock exchange, even though the German economy is limping. Getty Images

The German stock index is rushing from record to record – even though the German economy is shrinking.

The stock exchanges are celebrating price fireworks, at the same time companies, associations and economists are warning of an economic decline in Germany. How does this all come together?

We name the most important reasons why the current development is by no means irrational, but rather easily explainable.

Good times, bad times – the German economy is currently experiencing both, at the same time. Times are good for many investors on the stock market. The German stock index is rushing from record to record. The DAX has gained four percent since the beginning of the year. Year-on-year it is 13 percent. This helps millions of stock savers build wealth and plan for retirement. Many companies increase dividends and provide welcome additional income. Times are obviously bad for the German economy. The economy is stuck in the quicksand of a tough recession. Economic performance is shrinking. The prospects are considered bleak. Companies, associations and economists are warning of an economic decline in Germany.

Price fireworks on the stock markets, a mood of doom in the economy: how does that fit together?

The divergence between stock market prices and the economy only appears to be a contradiction. There are numerous rational reasons for the current situation. We explain the most important factors. It helps to first take a closer look at the development of share prices.

1. The large DAX stocks are rising, but small and medium-sized stocks are not

The German stock index Dax rose to more than 17,600 points in the middle of the week. Anyone who invested in the 40 largest German stocks that make up the Dax at the end of October saw their value increase by almost 20 percent.


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However, the increase in value was largely limited to DAX shares, and even there only to some of the values. The M-Dax with the 50 next largest stocks performed significantly worse. The M-Dax is around ten percent lower than a year ago. Since the beginning of the year, mid caps, i.e. stocks with a medium market capitalization, have lost almost four percent. The S-Dax for 70 selected smaller stocks cannot keep up with the DAX either. At least it moves roughly stable. In a year-on-year comparison, the S-Dax rose slightly by three percent.

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“The DAX is not a pure reflection of the German real economy,” says Frankfurt finance professor Emanuel Mönch tagesschau.de together.

2. German companies do not mean doing business in Germany

The divergence of the stock market indices points to an important reason why the DAX is rising so strongly despite the economic crisis in Germany. Because the Dax mainly contains the shares of large international, mostly global companies. Corporations like Siemens, Volkswagen, Adidas and Deutsche Bank are German, but their market is the world. For the DAX 40 companies, the foreign share of sales is around 75 to 80 percent. A much higher proportion of production also takes place abroad than in small and medium-sized companies.

So it’s not the domestic business that makes the DAX companies more and more valuable on the stock exchange. “They generated most of their sales and profits abroad,” emphasizes analyst Konstantin Oldenburger from broker CMC Markets.

“For the large DAX companies, only a small part of the business takes place in Germany,” agrees Andreas Hackethal, finance professor at the Goethe University in Frankfurt. “There are various growth impulses on the global markets that can influence prices here too.” Globally, the prospects are far better than in Germany.

3. Stock prices reflect expectations, not the situation

Stock prices generally do not reflect the current situation, but rather the expectations of the future. They reflect the expected development of growth, profits and returns in the prices. So you price in expectations. And these expectations are better worldwide than the mood and the immediate prospects in Germany.

The economists at Deutsche Bank Research also point this out. The latest economic data from the global economy and especially from the USA would have been a positive surprise. The labor markets in particular are very strong. At least that also applies to Germany.

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When companies present their results for the previous quarter, share prices do not react to whether the company made a profit or loss, but rather whether the results and outlook are better or worse than the expectations reflected in the prices.

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A recent example that contributed to the price rally makes it clear that this can also move the markets as a whole. It shows what is currently driving expectations around the world and thus the prices.

4. Artificial intelligence raises great hopes

Recent breakthroughs in artificial intelligence (AI) applications are the biggest driver of stock prices. This is linked to the hope that the new level of digitalization will increase productivity – and thus enable more growth and profits. “Artificial intelligence has huge earnings potential – and this has only now begun to be expressed in profits,” said equity strategist Sven Streibel from DZ Bank to the “Handelsblatt”.

The US company Nvidia, which produces special chips for AI applications, is currently an example of this. It once again significantly exceeded expectations for growth and profits last week.

“Investors are slowly realizing that AI could have greater economic importance than expected,” says finance professor Mönch. Hackethal agrees: “Technological leaps in AI and robotics can dramatically reduce costs for companies in all industries by increasing productivity.” This creates optimism among market participants – but not alone.

5. Hopes for interest rate cuts are driving prices

In addition, there is a positive general mood for stocks because investors assume that the time for central banks to raise interest rates is over. Rather, there is an expectation on the markets that the US Federal Reserve and the European Central Bank (ECB) will cut key interest rates this year.

Lower interest rates boost stock prices in two ways. First, they make investments in fixed-interest, lower-risk securities less attractive. This means more money flows into the stock markets. Second, lower interest rates improve the ability for businesses to invest and for consumers to consume. This strengthens the economy and opens up business and profit opportunities for companies.

While the economy – and the mood – is currently still suffering from high interest rates, the prospects of falling interest rates are now being priced in on the forward-looking stock markets. “It is a typical phenomenon that stock markets rise sharply at the beginning of a recession,” says Mönch.

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6. The recent crises are priced in

Stable conditions are just as important for companies and stock exchanges. The global economy has been – and is – far away from this for some time: this is what the corona pandemic, Russia’s attack on Ukraine, the war in Israel and Gaza and the disruptions to important transport routes in world trade represent. But the consequences of these crises have been priced into share prices for some time, experts say. As long as the situation does not worsen and there are no new crises or wars, investors expect the situation to stabilize. An indication of this are lower and stable energy prices or the first signs that freight rates for container ships through the Red Sea are falling.

The hopes also point to important risks.

But: price drivers also show the greatest risks

The recent sharp rise in share prices reflects optimistic expectations. They rest on three pillars: a stable geopolitical situation, falling interest rates and productivity gains through the use of artificial intelligence. If hope turns out to be deceptive, this can depress sentiment and prices.

Analyst Oldenburger also sees the discrepancy “between the economic reality in Germany” and a stock market at record levels as a risk. “For now, however, the ongoing enthusiasm for artificial intelligence is pushing the stock market higher.”

In its capital market outlook, the asset manager Bantleon warns that Nvidia has developed into a “projection surface for AI fantasies of all kinds” and predicts: “The AI ​​hype doesn’t seem to want to end – not yet.”

The Deutsche Bank Research team points out that the stock rally is limited to a few stocks, even in historical comparison. They would pull the entire markets up. Bantleon also notes that there is a “growing gap between front runners and the rest of the field” in the stock market. This “carries corresponding potential for disappointment in the future.”

There is also a risk lurking in interest rate hopes: that inflation will prove to be more stubborn and that central banks will therefore keep their interest rates high for longer. This week, new data on inflation in the USA, Germany and the Eurozone are therefore being looked forward to with particular interest.

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