DAX Outlook 2023: Choppy Waters Ahead

Heading into the new year, the benchmark stock index in Germany is heading for some choppy waters. But things might smooth out in the summer.

Exposed to industrial demand for energy

Of all the major economies in Europe, Germany is perhaps the most exposed to the shift in energy dynamics since Russia invaded Ukraine. It's not just a matter of how much gas or what percentage of the energy matrix is. Services have more flexibility in adapting to energy demand
compared to industry. And Germany's economic base still remains in industry. A lot of high-tech industry too, but industry nonetheless.

This is a particularity of the DAX. Despite the recent rebalancing to try to even out sector representation, it still is heavily weighted towards traditional heavy industries. Even the non-manufacturing companies listed are still significantly exposed to energy, such as e.on, and the company with the largest weighting, Linde.

Germany has managed to reduce its energy consumption by a fifth, but at the cost of several high-energy factories shutting down. Some of them manufactured key components for the rest of the value chain, such as car windshields.

Potential for recovery in Q2 looks better

The next couple of months is crunch time for energy, as demand is expected to fluctuate depending on the weather. Germany believes it has enough storage to get through the winter, and the new LNG terminals will be up and running by next winter. However, there is uncertainty, which could keep investors nervous until March.

Meanwhile, inflation is expected to remain high, and the ECB just revised their CPI outlook for next year to the upside. That could mean further rate hikes, as the shared central bank is relatively behind compared to its peers. It has more room to tighten. Also, in March, the ECB will start rolling off the first tranche of bonds in its balance sheet normalization.

After that, with a clearer view of how the war in Ukraine might evolve, the rate path of the ECB, and the energy situation for German industrials, the DAX could have a chance at recovery.

A downward consolidation for now

The Germany 40 index is going through a period of downward consolidation after peaking at 14675 and it is still unclear whether the pullback has been completed already. The rising flag could reach further depths towards the 13k handle if the short-term support at 13685 succumbs to pressure. However, it appears to be a bullish flag unless the descent goes as deep as the 12k handle.

If we see a break past the 6-month high, the 15k handle will return to the spotlight. Only a breach of the said level could expose the 2022 top of 16300, with an interim ceiling at around 15700.

Key takeaways

The DAX is facing some challenges in the near term due to Germany's dependence on energy and uncertainties related to energy dynamics, inflation, and the ECB. These issues are expected to persist until March, after which the DAX may have a chance at a recovery depending on the resolution of these factors. In the meantime, the index experiences a downward consolidation, which could be part of a bullish flag pattern that eventually resolves higher.