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Why the DAX index is reaching ATHs while the economy is contracting for the second consecutive year

The difference between DAX and the economy
The DAX, Germany’s main stock market index, does not accurately reflect the country’s economic performance. This is because the sector composition of the German economy is quite different from that of DAX. For example, manufacturing, software, and technology sectors make up over 50% of DAX, but these sectors have a much smaller share in the national economy.

Over the past decade, the composition of DAX has changed rapidly, with car manufacturers, which previously made up 17% of the index, now only representing 7%. Meanwhile, the technology sector has grown from 8% to 18% during the same period.

Key factors for DAX’s growth
The companies in DAX are significantly more export-oriented than Germany’s economy as a whole. According to Deutsche Bank strategists, around 80% of DAX companies’ revenues come from outside Germany, with a significant portion (24%) coming from the U.S., compared to 20% from Germany. Additionally, the bullish movement of DAX is driven by just a few key companies. Similar to the “Magnificent 7” effect on the S&P 500, companies like SAP, Deutsche Telekom, Allianz, Siemens, Munich RE, and Rheinmetall are responsible for nearly all of the index’s performance. Without these companies, DAX would have only grown by 5% in 2023.

The German economy
While DAX has been performing well, the German economy has struggled recently, with its GDP shrinking consecutively in 2023 and 2024. The GDP forecasts for the coming quarters remain weak, with growth predictions of just 0.2-0.3% for 2025, putting Germany behind other major European economies such as the UK and France.

DAX valuation
Currently, DAX trades at a price-to-earnings (P/E) ratio of 15.7, which makes it appear significantly cheaper compared to the S&P 500’s P/E ratio of 25.2. While this makes it seem relatively inexpensive, the reasons for this might be linked to the structural differences in Germany’s economy, which justify its fair valuation despite the country’s economic struggles.

Small and medium-sized companies
While DAX has shown strong results, small and medium-sized companies, which are more closely tied to Germany’s domestic economy, are not performing as well. The MDAX and SDAX indices, which track these companies, have seen significant losses in 2024, highlighting that Germany’s economy still faces serious challenges that aren’t reflected in the performance of large companies.

Conclusion
The DAX index is heavily influenced by large, export-oriented companies, which makes it an unreliable indicator of the overall economic health of Germany. Despite DAX’s strong performance, the broader economy is facing difficulties, and smaller companies are still struggling. Investors need to be cautious, as the gap between DAX’s performance and the realities of the German economy could continue to widen in the coming years.

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