German bull runs out of puff

German stocks have soared over the past few years, with the DAX index more than trebling to 8,000 from its 2003 low before falling back amid global credit jitters.

The index is now likely to find it "increasingly difficult to shrug off the US financial crisis", an analyst told Handelsblatt.

That's because the fundamental outlook is clouding over. German growth hit an annual rate of 2.4% in the third quarter, but the economy is "running out of puff", says Wirtschaftswoche.

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Strong exports and business investment have provided most of the momentum, but the corporate sector's order intake is set to slow amid weakening US and global growth, the strong euro and previous domestic interest-rate rises.

Tightening credit conditions also cloud the outlook. A slide in leading indicators, such as Ifo Business confidence and ZEW investor confidence indices, presages more economic cooling; the latter is at a near-15 year low.

The question for the domestic economy is whether consumers will finally open their wallets; Capital Economic notes consumption in the third quarter was only 0.2% up on the previous year, although as spending has historically tracked the improving labour market, the drop in unemployment to a 14-year low bodes well. One estimate sees GDP declining to 1.9% next year, even if consumers spend more.

German firms will struggle to cope with high oil prices and the strong euro about half of the DAX firms' sales are made abroad even though they are now exporting more to Asia than in previous years, says Eric Chaney of Morgan Stanley. Goldman Sachs reckons that the Dax will now "struggle to outperform" as these factors take their toll on earnings. DAX profits, which have been rocketing for five years, are expected to grow by just 10% next year, compared to 20% in 2007, says Handelsblatt, although they will still outstrip the European average, according to JP Morgan.

Note too, says Stefan Hajek in Wirtschaftswoche, that the market isn't as cheap as it looks. It's on a p/e of around 12, but strip out the ailing financials and the average p/e has recently been in the high teens. Throw in ongoing credit jitters and the outlook for the next few months is uninspiring.