Germany's stock market "catch-up trading" has come to a halt: MDAX underperforms DAX, and the 500 billion stimulus is difficult to realize.

It may seem somewhat illogical to observe the weak performance of the German economy given the massive stimulus measures injected by the government. However, even billions of euros in spending cannot resolve all of investors' concerns, and the results of the local elections on Sunday have intensified one particular worry. The Federal Statistical Office of Germany announced on Monday that output decreased by 1.1% in July, while economists had previously predicted a growth of 0.2%. The initial data for June showed a slight increase but has since been revised to zero growth. The bullish logic from last year was not without reason, and the market paid a premium for it in advance. The German government's proposed spending plan of 500 billion euros (approximately $580 billion) alone drove the mid-cap MDAX index up by 20% by 2025, while a UBS-tracked stock portfolio of beneficiaries, excluding defense, skyrocketed by 65%. However, this year's situation has become an audit of the previous fervor. The MDAX index has risen only 5.7%, lagging behind the DAX index's modest gain of 6.4%. On paper, German mid-cap stocks remain relatively cheap, and the beneficiaries of fiscal spending have not demonstrated any excess returns. The follow-on trades in the German stock market have effectively ceased. The first reality check lies in where this money has actually gone. The Ifo Institute for Economic Research estimates that 95% of the new debt allocated for spending last year was used to fill daily budget deficits, rather than for additional investment. The city of Berlin plans to spend over 2 billion euros of its allocated funds on planting 700,000 trees, while the police and clinics are still waiting for renovations. Economists warned as early as last year that the fund was financing consumption projects, not genuine investments. A survey of economists showed that Germany's economic growth expectations for this year are 0.9%, and 1.1% for 2027. While this is better than the stagnation of GDP data from the past two years, it is by no means evidence of a strong economic recovery. Investors were promised prospects for the construction of roads, railways, and power grids, but so far, they have received only accounting adjustments on paper. The expectations for excess returns in Germany in 2025 are facing a reality check. The political capital sustaining the market's enthusiasm for the spending plan has largely been depleted. Chancellor Merz's approval rating has dropped to one of the lowest levels on record for that position, with the latest polls showing only 15% of the public satisfied with his work. Last Sunday, Saxony-Anhalt held elections for a new parliament. The far-right Alternative for Germany (AfD) won 44% of the vote, marking the party's best historical performance in state elections and coming just one step away from an absolute majority. Two more state elections are set to take place in the next two weeks. Morgan Stanley's Chief European Economist Jens Eisenschmidt wrote in a report last week: While we still view a coalition government's collapse as a tail risk, the potential outcome under such a scenario could lead to a minority government, rather than immediate early elections. However, if Merz achieves a weak electoral result, it may trigger leadership considerations. The AfD achieved its best state election results ever. Next comes a new round of energy shocks. With the Strait of Hormuz effectively blocked and inventories below seasonal norms, European natural gas trading prices are near 75 euros per megawatt hour, reaching the highest level since January 2023 and more than doubling since the beginning of this year. Even if prices retreat, the damage has already been inflicted, and rising inflation data is sure to erode real income and consumer willingness. Areas in Germany where stock performance has been decent are concentrated in artificial intelligence and its derivative sectors. The defense sector has peaked and retraced, while Germany's traditional industrial core has become a loser, with Volkswagen being removed from the Euro Stoxx 50 index this month. The slump in the automotive industry casts a shadow over local finances. The Mercedes-Benz Group and Porsche's location in Stuttgart have revised their trade tax forecasts for 2026 down from a record level of over 1.6 billion euros in 2023 to 700 million euros. The city has passed its first austerity budget since 2009. Other municipalities face similar restrictions, further deepening an already challenging economic predicament. Although Germany topped the list of most favored markets in the Bank of America fund manager survey this summer, capital inflows have remained sluggish. Due to weak momentum, lowered earnings forecasts, and deteriorating management sentiment, Germany is close to the bottom of Morgan Stanley's rankings. The most powerful counterweight to the prevailing pessimism comes from the country's institutional support. The fiscal plan has been anchored in the constitution, and abolishing it would require a two-thirds majority that no faction possesses. Andreas Rees, Chief Economist at Unicredit Bank Germany, wrote: Overall, we expect more political noise in the coming weeks, but Berlin will not fall into political paralysis. Some reform measures may be diluted or postponed until after the end of 2026, but wider reform progress is still expected to remain on track. For now, Germany still maintains an advantage with a debt-to-GDP ratio of 64%. However, plans to increase debt by over 200 billion euros in 2027, combined with rising interest rates, are weakening the arguments about fiscal space. Fortunately, the DAX index's international revenue structure means that Germany's own problems do not equate to problems for the index. Among major EU countries, Germany has the greatest debt maneuverability. There are still potential opportunities in stock selectionsuch as in semiconductors, power grids, and the areas where stimulus funds will eventually land. But the range of choices is limited, and trading days are becoming increasingly crowded. Betting on a broader market outlook for Germany requires investors to back a government that seems to be losing investor trust, to stake on a country that has become a hostage to two wars in terms of energy security, and on an economy where key firms are caught in structural decline. Even for optimists, this is a test of patience; funds will not flow in until 2027, while the challenges are already apparent. This is less about an incorrectly treated discount and more about the risk-reward ratio playing its proper role.