A confluence of factors — including rising exports, strong corporate performance, high but declining unemployment, falling labour costs, a favourable currency environment, economic and corporate reforms, and new political leadership — have set the stage for Germany’s re-emergence as Europe’s economic powerhouse, spurring cautious optimism.

“Germany appears to be at a turning point, similar to Japan,” says Chuck Bastyr, portfolio manager of BPI Global Discovery Fund at BPI Global Asset Management LLP in Florida. “It has endured low economic growth since the beginning of the decade, but conditions are changing even though many obstacles remain.”

Germany’s GDP is expected to grow by 1.8% this year, vs 1.1% growth in 2005. Although this is marginal, it’s a positive sign for the world’s third largest economy, which has stagnated in recent years.

“The economy is getting better, but it’s not super-strong,” says Don Reed, president and CEO of Franklin Templeton Investments Corp. in Toronto and portfolio manager of Templeton International Stock Fund. There have been some reforms, he adds, but labour costs remain expensive, even though “wage demands are not high.” The unemployment picture is less than favourable, with Germany’s jobless rate is slightly more than 11% — twice the rate in Britain and among the highest in the region.

Although Germany’s unit labour costs remain relatively high compared with its neighbours, they have been stable over the past five years, while labour productivity has risen significantly. Comparatively, labour costs have edged up in some other European countries, such as Italy, making German goods more competitive.

Exports, which have grown by almost 50% in nominal terms over the past five years, have been fuelling the German economy, according to Stephen Way, senior vice president and portfolio manager with AGF Funds Inc. in Toronto. AGF offers the only Canadian mutual fund focused solely on Germany, AGF Germany Class Fund.

As the world’s largest exporter, Germany’s exports account for more than 30% of its economy. And the rise in exports has been supported by several factors, including a weaker euro, which declined by about 13% against the U.S. dollar last year. This made German goods more affordable to foreign buyers, increasing productivity and stable wage costs in the process. Way says he expects a 6.5%-7% increase in exports in 2006.

“Germany has always been a great exporting nation,” Bastyr says. “It is widely recognized for its manufacturing capability and is known for quality goods, especially in the industrial sector, which is expected to benefit from rising Asian demand.”

He adds that this “new cycle” in Germany is expected to focus more on adding capacity, particularly in manufacturing.

“As exports pick up, industries will expand, jobs will be created and business investment will begin to rise,” adds Way.

This will probably reverse the declining trend in consumer spending and spur the domestic economy.

“Germany is beginning to diversify from within, which will balance out the export sector,” says Bastyr. “We are seeing a greater focus on the service sector, with significant growth in this area.”

Evidently, those who invest in Germany are seeing some light at the end of the tunnel. “It is one of our favourite markets heading into 2006,” says Way.

He adds that stocks in Germany’s benchmark DAX stock index recently traded at an 18% average discount to stocks in Standard & Poor’s 500 composite index, based on price/earnings. They are the second-cheapest in the developed world on a price/book basis.

Reed, a bottom-up stock-picker, is not as optimistic as Way from a macro perspective, but sees value in specific large companies with global operations, such as Munich Re, Siemens AG and E.ON AG.

> Munich re. The world’s largest reinsurance company is focused on producing stable reinsurance profits and on raising the returns on its primary life and health insurance businesses. It is expected to benefit from industry trends that indicate higher volumes and prices. The stock closed at 106.80 euros on Jan. 19, and traded in a 52-week range of 83.40-121.84 euros. (On Jan. 27, one euro was equal to C$1.39.) In January, UBS AG, headquartered in Zurich, set a target price of 112 euros for the stock.

> Siemens ag. Europe’s largest electronics and electrical engineering firm with its worldwide operations, is streamlining its operations and is considered a restructuring play. In January, New York-based J.P. Morgan Chase & Co. recommended overweighting the stock, with a target price of 74 euros, while Frankfurt-based Dresdner Kleinwort Wasserstein rated it a “buy,” with a target price of 72 euros. Siemens closed at 69.72 euros on Jan. 19 and traded in a 52-week range of 55.8-75.67 euros.

@page_break@> E.on ag, one of Germany’s largest energy companies, is transforming itself into a European multi-utility company with operations in electricity, natural gas and water. It is expected to benefit from rising energy prices. The stock closed at 88.33 euros on Jan. 19 and traded in a 52-week range of 63.90-90.97 euros. In January, UBS set a target price of 95 euros for the utility company.

Way, who also likes Siemens and E.ON, sees both companies as restructuring plays. He says Siemens has been a poorly managed company whose balance sheet is on the mend. On the other hand, E.ON has been selling off its non-core assets to concentrate on its energy operations. It has also increased its dividends, distributed cash to shareholders from the sale of its non-core assets and recently approved a share buyback.

Way has a neutral stance on the German insurance sector, which has benefited from favourable pricing trends since 9/11, and favours Allianz AG, one of the world’s largest insurers. Allianz closed at 124.66 euros on Jan. 19 and traded in a 52-week range of 89.15-136.59 euros. In January, New York-based Merrill Lynch & Co. Inc. expected Allianz to consolidate its gains; Merrill Lynch believes that the stock is fairly valued at 128 euros.

Both Bastyr and Way believe the German real estate sector is set for a takeoff. “Only 43% of Germans own their own homes, which is one of the lowest rates in Europe,” Way says. Citing statistics from the Organization for Economic Co-operation and Development, he adds that German housing prices have fallen by an average of 6.8% between 1994 and 2004 and are 26% undervalued. This is partially due to the “lacklustre German economy,” he says. Comparatively, housing prices have quadrupled in Ireland and doubled in Britain.

But housing prices are beginning to pick up in Germany as investors start to target the sector, which represents Europe’s largest residential property market. “Property is one of the few areas that has lagged for a long time in Germany,”says Bastyr. “But that is set to change in a more investor-friendly environment that allows for real estate investment trusts and a wider range of mortgages.”

Way likes Hypo Real Estate Holding AG, which offers various commercial real estate financing products in a dozen countries, with 30% of its business in German real estate financing.

Bastyr also sees opportunities in banking and retail. He favours Metro AG, Germany’s largest retailer, which operates some 2,400 stores in 28 countries. He expects Metro to pick up as consumer sentiment improves on the back of the recovery in Germany. Metro closed at 39.30 euros on Jan. 19 and traded in a 52-week range of 35.95-44.39 euros. Merrill Lynch had a neutral rating on the stock in January.

In the banking sector, Bastyr likes Deutsche Bank AG, one of the largest corporate and investment banks in the world, and Commerzbank AG, Germany’s third-largest bank.

“The banks will benefit from the reflationary environment that is beginning to evolve, as well as increased demand for credit,” he says.

Reforms in Germany have been slow. The country’s reform program, Agenda 2010, which was launched in 2003, has achieved only modest gains in the labour market and taxes. There is some optimism, however, that the coalition government of newly elected Chancellor Angela Merkel will bring about much needed change.

In the meantime, Germany appears to be an investment opportunity in the making. IE