By Brian Swint
Imagine if newly elected President Donald Trump just took office but his administration and the Republican-controlled Congress had almost no power to increase the budget, its hands tied by law.
Then imagine that promises of tax cuts and increased spending on welfare, border control, and defense are all meaningless because the Constitution restricts budget deficits to a fraction of where they are today. Lawmakers would be forbidden from selling more bonds to pay for expenditure or savings.
That, in turn, would hurt the stock market by damping demand in the economy, undercutting earnings for everything from Big Tech to Big Oil.
Well, welcome to Germany -- where that's more or less been the case for years. The country's balanced budget amendment, known as the debt brake, was passed in the wake of the 2008-2009 Global Financial Crisis and took effect in 2016. It puts a limit on how much spending can exceed the tax take as a percentage of gross domestic product, giving the government a very difficult hand to play when the economy needs stimulus to get out of a slump.
Standout Stocks
But the rule is about to be overhauled. That could be a big deal for German stocks, especially those related to infrastructure -- such as engineering firm Siemens, or its spinoff Siemens Energy that has quadrupled in value this year. Defense companies such as ThyssenKrupp could also be a good bet. It would give the government a chance to unleash a flood of much-needed investment. U.S. investors can take advantage if they move quickly before the changes come into effect.
Rheinmetall is another defense company with a solid record of late. It has gained 124% this year but still enjoys a Buy rating from 12 of 13 analysts surveyed on FactSet, with an average 9% upside in its target price from current trading. It has a price to forward 12 months earnings ratio of 21.5%, putting it in line with peers.
Siemens, which still owns about a third of Siemens Energy, hasn't risen as much lately but could still be the beneficiary of infrastructure spending. It's only up 7.3% this year and has a P/E ratio of 16.8, FactSet data show.
Arguments about whether to change Germany's debt brake have been going on for years and came to a head when one bloc of the three-party government refused to budge on any loosening. The governing coalition has collapsed, new elections will happen in February, and the party leading the polls says it's time to rethink it.
"The policy which would excite the German stock market would be a commitment to abolish its fiscal constraint," wrote Jefferies strategist Christopher Wood in his Greed & Fear newsletter last month. "This could open the way for a surge in fiscal spending."
Germany isn't the only country to go through political turmoil. France passed a vote of no confidence in its prime minister on Dec. 4.
Germany's DAX index hasn't done too badly this year -- it's up more than 20% since Jan. 1 and has touched new records recently. But that's in large part because the blue-chip companies represented there make a lot of money in the U.S., where stocks have done even better. The S&P 500 is up more than 25% this year.
'Fiscal Straitjacket'
It's worth noting that the debt brake's limit of 0.35% of GDP is adjusted for the economic cycle and there are exceptions for when it must be followed -- the country's current budget deficit is actually about 2% of GDP already. But, for comparison, the U.S. budget deficit last year was about 6% of GDP, and independent forecasters expect it to go higher.
To be sure, whichever parties win the election probably won't abolish the debt brake completely. It was established with the hope that it would enshrine the country's commitment to prudence and prevent future generations from having to pay for excessive current spending. It narrowed the European Union's already-tight regulation that deficits could not exceed 3% of GDP -- a rule that Germany had broken in the early 2000s before the crisis struck.
It's not easy to change the constitution, either, but there could still be a lot of room for maneuver to loosen Germany's fiscal constraints. The current parliament may even try to alter the debt brake before the Feb. 23 election to ensure smaller parties can't block reform, which will require a two-thirds majority in the Bundestag.
"We expect Germany to modernize its outdated fiscal straitjacket to create space for a permanent and reliable increase in defense and infrastructure spending as well as for an upfront cut in business taxes, " said Holger Schmieding, an economist at Berenberg. "The best thing Germany could do to lower the risk of Trump lashing out with major tariffs against Germany and the EU would be a strong commitment beforehand to raise defense spending significantly."
Trump & Russia
Trump's election adds extra urgency. Germany's economy hasn't grown significantly for years, and is expected to contract slightly this year. An aging population, the energy shock from Russia invading Ukraine that has kept natural-gas prices higher in Europe than elsewhere, and the economic slump in major trading partner China are all weighing heavily on Germany's outlook.
Some analysts see a chance that even changing the debt brake won't be enough to pull the economy out of the doldrums.
"While a reform of the debt brake will prevent German fiscal policy from being tightened excessively, it will not be enough to counter the many big headwinds to economic growth there," said Franziska Palmas at Capital Economics. "Accordingly, we still expect GDP growth to average only around 0.5% in 2025 and 2026." The Congressional Budget Office sees U.S. growth at around 2% for the next few years.
Still, Germany's roads and railways are suffering from years of underinvestment, and the country needs to spend more on the energy transition after its natural gas supplies from Russia were cut off by the war.
With the deck currently stacked against it, a new debt brake may be the best hand Germany can play.
Write to Brian Swint at brian.swint@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
December 09, 2024 00:30 ET (05:30 GMT)
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