By Tommy Stubbington
Tensions between Russia and the West over the conflict in
Ukraine are casting a darkening shadow over much of Europe's
economy, but Germany's markets in particular are feeling the
strain.
Investors have rushed to Germany's ultra-safe bonds--pushing
them to record highs, while stocks have found themselves in the
firing line.
Frankfurt's DAX stock index, packed with the exporters and
industrial powerhouses that are the engine of Europe's largest
economy, has fallen 7.8% in the last month. That compares with a
fall of 4.4% for the pan-European Stoxx Europe 600 index. Outside
the euro zone, the U.K.'s FTSE 100 and the S&P 500 are both
down by less than 3%.
European Central Bank President Mario Draghi underlined Thursday
that tit-for-tat sanctions between the European Union and Russia
pose risks to euro-area growth as a whole. But Germany's high
profile, deep markets, and large exports to Russia make its stocks
more vulnerable.
"There's a perception of German industry and Russian energy
being closely intertwined," said Neil Wilkinson, a senior fund
manager at Royal London Asset Management, which oversees $76
billion of assets. "We have a big universe of stocks we can invest
in. With so much uncertainty, it's pretty hard to justify holding
firms with a big chunk of their business in Russia."
The latest wave of Western sanctions last week targeted sectors
such as finance, oil and defense, tipping Russia's slowing economy
toward recession. Russian President Vladimir Putin hit back
Thursday, imposing bans on imports of food and other products from
the nations that imposed the restrictions.
A number of German firms have already flagged a slowdown in
their Russian businesses.
Sporting goods company Adidas highlighted a deteriorating
Russian economy when it last week issued a profit warning that sent
its shares plunging. The chief executive of engineering giant
Siemens said geopolitical tensions arising from the Ukraine
conflict are a "serious risk" to Europe's growth.
Some investors are steering clear of German stocks, favoring the
likes of Spain and Italy from Europe's erstwhile trouble spots
known as the periphery instead.
"[Economic sanctions on Russia] are a constraint for certain
companies. That's the reason we prefer peripheral stock markets to
Germany," said Gregor Hirt, chief investment officer for Europe at
UBS Global Asset Management, which manages $674 billion of
assets.
Germany is responsible for 30% of European Union goods exports
to Russia, according to data compiled by RBC Capital Markets.
Although only 1.3% of Germany's gross domestic product, that's the
largest share of any major European economy.
The standoff over Ukraine could also disrupt the westward flow
of energy as well as the eastward flow of goods. Russian natural
gas accounts for nearly half of German gas consumption, RBC
says.
As stocks decline, Germany's government bond market--the euro
zone's safest and most liquid--has benefited. The German 10-year
bond yield on Friday sank to an all-time low of 1.02%. Yields fall
as prices rise. Yields on two-year German debt this week turned
negative for the first time since May 2013--meaning investors are
once again happy to pay the German state simply in order to park
their cash.
To be sure, other European economies also have strong links with
Russia. Finland, for example, imports all of its gas needs through
Russian pipelines. "There is a possibility of a crisis, if the
situation continues to develop as it is doing," Finnish Prime
Minister Alexander Stubb told reporters this week. But Germany's
high profile and large international financial markets put it
uppermost in many investors' minds.
For some, the pressures on German stocks are symptomatic of a
worsening outlook for euro-area markets as a whole.
"If the sanctions last, we could see a permanent loss of
business for some companies with substantial sales in Russia," said
Patrick Moonen senior equity strategist at ING Investment
Management, which has EUR322 billion of assets under
management.
Mr. Moonen said the vulnerability of the region's economy to an
escalation of tensions with Russia was a key driver for a decision
earlier this week to scale back holdings of euro-zone stocks and
buy emerging-market equities instead. ING IM is now underweight
euro-area equities.
Write to Tommy Stubbington at tommy.stubbington@wsj.com
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