One of the biggest surprises of 2012 was the fact that the German stock market lead basically all of the industrialized stocks markets, despite all the fears about the Euro-zone during the first half of the year.  Germany’s benchmark Dax share index closed the year at a five-year high in a year in which European equities outpaced global and US rivals for the first time since the depths of the global economic crisis.  The resurgence in equities shows how investors have re-rated Euro-Zone break-up risks following a pledge by Mario Draghi, European Central Bank president, to safeguard the euro zone’s integrity.

We do expect the Euro region to improve, or at least bottom out, in 2013.  Although the recovery will still be tepid, the latest economic data coming out of Germany suggests its mighty economy is starting to make a comeback.  Both the services and the manufacturing indices turned higher and above expectations in December.

European Economic Growth Stabilizing

One of the main reasons for thinking that Germany is on the road to recovery is that much of the boom of the last decade came on the back of the explosive growth of the emerging markets, and China in particular.  With the recent strength in China, German capital goods exports as well as high-end consumer good should start to gain some momentum again, despite continued weakness elsewhere in the Euro-Zone.

The big move markets have been waiting for though is the switch from bonds back to stocks by both the public as well as many large pension funds.  The impact of two bear markets in 10 years drew money away from riskier assets such as stocks and into the safer asset classes, particularly government bonds.  Stocks are now historically cheap compared to bonds.  We pointed out last month that fact alone won’t lead to a shift in assets back to stocks as we have seen these anomalies go on for years before.  The catalyst might be a shift in view about interest rates.  A continued recovery in global growth and worries about inflation could start the movement out of bonds that has dominated fund flows over the last five years. Since hitting a recession-driven low in March 2009, the Dow Jones Industrial Average has doubled in value. But many ordinary investors remain too fearful to join in the gains.  After two stock collapses in one decade—2000-2002 and 2007-2009—along with scandals, the rise of high-frequency trading and worries over Washington’s ability to rein in debt, investors are skeptical about stocks.  Individual investors yanked a net $900 billion from U.S. equity funds since January 2000, according to fund flow tracker EPFR Global. Stocks and stock mutual funds now make up 37.9% of the average U.S. household’s financial assets, down from 50.5% during the height of the tech-stock boom in 2000, according to the U.S. Federal Reserve.

Will Bond Money Move Stocks above 12 year range?

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