Igor Kutyaev
The Global X DAX Germany ETF (NASDAQ:DAX) gives investors exposure to the DAX Index, a portfolio of stocks representing the premier companies listed in Germany.
In recent months, the DAX ETF has staged a strong rebound, as fears of an imminent energy crisis have been averted. However, too much risk remains with European economies for me to feel comfortable holding the DAX ETF for more than a momentum trade.
Fund Overview
The Global X DAX Germany ETF provides exposure to the German DAX Index (“Index”), an index designed to track the 40 largest and most liquid publicly traded companies on the Frankfurt Stock Exchange. The DAX Index is similar to the Dow Jones Index in the U.S., representing the largest and most prominent companies in Germany.
Although the DAX ETF has been around for almost a decade, it has not been very popular with investors, with only $50 million in assets. The DAX ETF is relatively cheap, charging a 0.20% expense ratio.
Portfolio Holdings
Figure 1 shows the sector breakdown of the fund. The DAX ETF is heavily weighted towards industrials (20%), financials (16%) and materials (16%). The DAX ETF (and the DAX Index) is higher beta than the S&P 500, and has 3 Yr volatility (standard deviation) of 26.8% vs. ~21% for the S&P 500.
Figure 1 – DAX ETF characteristics (globalxetfs.com)
The DAX ETF’s top holdings represent the ‘champions’ of German business and contains many household names like SAP, Siemens, and Mercedes-Benz. Overall, the top 10 holdings amount to 60.0% of the fund’s assets.
Figure – DAX top 10 holdings (globalxetfs.com)
Returns
It is no surprise that the DAX ETF has not been able to garner any significant assets, as its historical returns have been poor. The fund generated average annual returns of -0.6% and -1.3% on a 3Yr and 5Yr basis to December 31, 2022 (Figure 3).
Figure 3 – DAX historical returns (morningstar.com)
Distributions & Yield
The DAX ETF pays a modest distribution of a trailing $0.72 / share or 2.6% yield. DAX’s distribution is paid semi-annually.
Will The DAX Rebound Continue?
Although the DAX ETF’s 2022 performance has been poor, with a -18.4% return for the full year, it has actually performed well in the fourth quarter, with a 3 month return of 25.1% (Figure 4).
Figure 4 – DAX has rebounded in Q4/2022 (stockcharts.com)
What happened and has Europe turned the corner?
Calming Energy Prices Have Boosted Stocks
A large reason for weakness in European economies and stock markets in the past year have been due to galloping energy prices, as Russia’s invasion of Ukraine disrupted natural gas supplies. This caused natural gas prices in Europe, represented by Dutch TTF natural gas prices in figure 5 below, to skyrocket during the summer months of 2022, reaching an incredible EUR 330/ MWh. This is equivalent to ~$100 / mmbtu!
Figure 5 – European natural gas prices reached EUR 330 / MWh in August 2022 (tradingeconomics.com)
Incredibly high energy prices forced many European factories to grind to a halt, and raised fears of a deep and prolonged recession.
Fortunately, the energy crisis was averted in the past few months due to an unusually warm winter, allowing gas in storage to remain near 80% halfway through the winter season. Furthermore, Germany recently passed a EUR 200 billion relief package allowing households and small businesses to purchase energy at 80% of 2021 prices.
Lowered energy prices reduced fears of an economic collapse and buoyed risk sentiment, allowing the DAX Index to rally 15%+ in the fourth quarter (Figure 6).
Figure 6 – DAX Index rallied 15% in Q4/2022 (stockcharts.com)
While A Hawkish ECB Have Boosted The Euro
Furthermore, an especially hawkish ECB, which raised interest rates by 50 bps in December and vowed to do more in the coming months, have reversed bearish sentiment regarding the Euro vs. the US dollar:
Anybody who thinks this is a pivot for the ECB is wrong. We’re not pivoting, we’re not wavering, we are showing determination and resilience in continuing a journey where we have. … If you compare with the Fed, we have more ground to cover. We have longer to go.
– ECB chairperson, Christine Lagarde, during December press conference
This has led to an 7%+ rally in the EURUSD FX rate in the quarter (Figure 7).
Figure 7 – Euro rallied 7% in Q4/2022 (Author created with price chart from stockcharts.com)
The combination of a strong DAX Index rebound plus a rallying Euro have allowed the DAX ETF to return more than 25% in the fourth quarter.
Significant Risks Still Remain
While Europe has been able to avoid the worst outcomes in the past few months, it is not out of the woods yet, as significant risks remain. First, European economies remain weak, with half of the European Union expected to enter a recession in 2023, according to the IMF.
Furthermore, if the Russia/Ukraine conflict drags on, it may provoke further escalation from Russia (Russia has repeatedly threatened to use nuclear weapons against Ukraine).
Finally, Europe may not be as lucky in the coming calendar year with regards to energy. A prolonged Russia/Ukraine conflict will continue to disrupt natural gas supplies while a reopening China could cause a surge in energy demand, especially for seaborne LNG cargoes.
This could cause European natural gas prices to increase in the coming months, putting renewed pressure on European economies.
Conclusion
The DAX ETF gives investors exposure to the DAX Index, a portfolio of stocks representing the premier companies listed in Germany. Historical performance for the DAX ETF has been poor. In recent months, the DAX has seen a major rebound on easing concerns of an energy crisis. However, with significant risks remaining on the horizon for European economies, I am hesitant to recommend a Buy for DAX ETF.
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