DAX Bullish On Draghi Bazooka

The year of 2016 has not been kind to German stocks as evidenced by the weak performance from the DAX during the first quarter. Since the beginning of the year, the DAX 30 index has fallen -7.57%, and the one-year performance has been notably worse. Recent monetary policy actions might benefit the benchmark equity index to a degree by boosting the valuations for risk assets, however, large-cap German equities continue to be dragged down by deteriorating fundamental undercurrents. The softness in the DAX 30 in many ways mirrors fading economic expansion in areas such as manufacturing and exports. Nevertheless, increased accommodation from the Central Bank combined with the potential for further Euro weakness create an optimistic background to sustain the rally that begin mid-February.

Supportive Policy Backdrop

One of the most visible aspects of central bank-led asset purchase programs is the reallocation of capital between different asset classes. During the Federal Reserve’s quantitative easing program, the gains in equity benchmarks directly correlated with central bank balance sheet expansion. Last week’s announcement of an additional €20 billion in monthly purchases from the European Central Bank is likely to produce a similar impact on regional indices such as the DAX 30. While the move to loosen monetary policy comes amid the rising risk of the Euro Area slipping into deflation, the further reduction in both the key lending and deposit rates is intended to raise consumption in order to spur inflation.

The key byproduct of these monetary policy measures is increased downside pressure on the Euro which should prove a temporarily benefit to the German export-economy and local corporations benefiting from international exposure. Should the Euro weaken further, it will likely induce additional upside in regional equities by making them cheaper on a relative basis to American or Asian peers. These monetary policy factors conceivably add to the bullish case for the German DAX 30 and a continuation of the rally begun in mid-February, creating the conditions for a reversal from the present downtrend. While the Draghi bazooka should produce good near-term results, the long-term bull case faces several distinct headwinds.