Asset Allocator: July 2015- What next for the DAX?

In this week Asset’s Allocator, David Stevenson examines the performance of the DAX, tracking its recovery since the financial crisis and how is Germany going to be affected in the future by the ongoing Greek crisis. David offers his conclusion as to whether there is still value in investing in German equities or whether investors are better placed focusing on other European economies.

 The content of Asset Allocator is provided by David Stevenson, an independent financial journalist. The views expressed in this page are those of David Stevenson only, and Societe Generale takes no responsibility for his views. The views expressed are David Stevenson's views as of the date of publication only.

 Neither David Stevenson nor Societe Generale accepts any liability arising from investment decisions you may make for your own account. This material is intended to give general information only and is not to be construed as investment advice. The investments mentioned may not be suitable for everybody and you should ensure that you fully understand the investment you intend to make before making an investment.

 This article has been published for marketing purposes and has not been prepared in accordance with those legal and regulatory requirements which are designed to promote the independence of investment research. There has been no prohibition on dealing ahead.  It was not subject to any prohibition on dealing ahead  prior to its publication on this website.




06/07/15- What next with the DAX?  


 The Greek Crisis has been characterised by many in the media – as well as within the world of investment – as an almost epic national struggle determining the fate of Europe between a poor, badly governed Aegean state and a dominant Teutonic state to the north, Germany. In this ridiculously simplistic narrative, decisions about where to put money to work within  the Eurozone have been delayed until the whole crisis is somehow ‘sorted out’. Thus when Greece looks to be teetering on the edge, many foreign investors sell off Eurozone shares generally and German shares in particular. One small example of this consensus view – in late June Bloomberg reported that equity strategists at Bankhaus Lampe KG and UniCredit Bank AG forecast that the benchmark German equity index the DAX may slip to 10,000 should Greece exit the euro (the index is currently trading at not far off 12000).

In this monthly asset class review of prospects for German equities I’m barely going to mention Greece. Greece is important for a whole bunch of reasons not least political but its influence over any decision to focus on German equities is negligible. Whatever happens to Greece, the repercussions on German companies should be minimal as the country isn’t even among its top 15 trading partners.

As we’ll explore investors in German equities have an excellent index to invest in – the DAX – and there is some evidence that prospects for growth are improving. Nevertheless my own take is that German equities are at best fairly priced and that there are much better bets within the Eurozone. This cautious view nevertheless doesn’t preclude the possibility that there may be a relief rally after an end to the Greek crisis althoug balance though I’d favour other equity indices over the DAX.

My bearish view on the DAX is in part based on a simple observation – German equities have already had a good post GFC (global financial crisis). In fact German stocks have more than tripled in value from a low in 2009 through to a peak in April this year.

The chart below from shows the performance of two indices since the dog days of 2008 through to the end of June 2015. The black line represents returns from the DAX index while the thin red line is the FTSE 100 index – the very thin grey line in the middle by contrast shows the 200 day moving average for the DAX index. After 2009 both indices staged a decent recovery but since 2013 the DAX has shot ahead of the FTSE 100 index and is now trading at well above its 20 and 200 day moving average even after a recent sharp reversal following Greece’s decision to seek a referendum on the bail out.  


 German equities have powered higher based on two very simple notions – the first is that until recently the Eurozone looked to have survived any crisis thrown at it. The more important cause for optimism is that the German economy is forecast to expand faster than the wider euro zone this year. The chart below from website Trading Economics shows how top line GDP growth within Germany has started to trend upwards with most economists expecting year on year growth in 2016 to exceed 2% per annum, helped along by a significant upturn in exports. Germany as the export powerhouse of Europe, running up a massive balance of trade surplus is till painfully accurate.



This rebound in the Germany economy has been felt most clearly in corporate earnings – wage growth in Germany has until recently been fairly anaemic. Analysts have been increasing their projections for earnings growth at DAX companies by 2.3 percent since the beginning of 2015. The chart below from website Yardeni puts this growth in an historical content and shows how earnings momentum has turned sharply positive in the last year. According to analysts within Societe Generale’s quantitative team 2015 earnings for all German stocks (including mdi and small caps) will grow 12%, falling back to 11.2% positive growth in 2016. By comparison UK stocks are expected to see an 8% decline in earnings in 2015 followed by near 13% growth in 2016. 


A more nuanced view of this surge in corporate profits can be seen in the next table – from investment trading website This summarises consensus analyst’s numbers for the 30 big corporate names within the DAX index. The two columns to the right show the change in analysts’ estimates over the last 1 month and 3 months. Over the last month 9 out of the 30 names have seen an increase in analysts’ estimates for earnings while at the 3 month level 12 businesses are now expected to see improved profits.



 But I also think that investors shouldn’t get too carried away with this talk of a big corporate recovery in profits  – although earnings may indeed be ticking up, corporate profit margins (measured in the next chart from website Yardeni again) are still fairly flat at around 5.5% profitability.



 Nevertheless despite these concerns, investment sentiment has turned decisively positive. Typical of this optimistic assessment is a report in Bloomberg citing Michael Kapler, an equity manager at Mittelbrandenburgische Sparkasse in Potsdam, Germany who claims this economic growth is “a brilliant environment for German companies, and a brilliant opportunity for investors. The index is cheap, European growth is picking up and earnings are improving. We’ll have the tailwinds from the low euro and oil come through more evidently in the next quarters. The DAX can see new highs.” Even analysts at JPMorgan Chase & Co. reckons it’s time to buy back into the DAX – the American bank’s analysts predict a 13 percent jump to 13,000 through to the end of the year.

Not surprisingly brokers report a surge of money into German equities. In fact one of the leading German listed ETFs tracking the DAX has experienced a second month of records inflows ($200m into one fund) after traders withdrew the most in three years upto April. Options traders have also grown more bullish on Germany. Contracts protecting against DAX swings are near the cheapest since March compared with those on the Euro Stoxx 50 Index.


What are you buying into? The DAX index


In the world of ETFs, the vast bulk of investment inflows have been into funds that track the DAX index. Alongside the FTSE 100 index in the UK and the CAC 40 in France, the DAX is one of the most widely followed blue chip indices in Europe. The index tracks the segment of the largest and most important companies on the German equities market. It contains the shares of the 30 largest and most liquid companies admitted to the FWB® Frankfurt Stock Exchange in the Prime Standard segment. The DAX represents about 80% of the aggregated prime standard’s market cap.

As you’d expect from such an index, when you invest in the DAX you are in fact putting money to work in a very concentrated series of big blue chips  and export orientated sectors – the next two charts below show index composition through to May 29th. Industrials, chemicals and automobile stocks account for more than half of the value of the index while the top five individual names in the index account for just 45% of the index.



Valuations: Fair value at best!


Cut through this blizzard of statistics and one fact becomes very clear as one gazes down the list of constituent stocks that include the likes of Daimler, Bayer and Siemens  – the DAX is a play on export orientated manufacturers, selling high quality goods and products both emerging and developed markets.

Take one example namely Bayer which is the biggest stock in the index in market cap terms and certainly one of its most profitable – the table below shows that sales are likely to hit 47 billion euros in 2015 with earnings before interest and tax at just shy of 8 billion euros. Bayer’s net income is forecast to hit 4.2 billion euros implying an above average profit margin of just under 10%. Debt levels at this 106 billion euro(market cap) Chemicals leviathan are relatively low (18 billion euros) and dividends are well backed with cash earnings – the dividend yield is currently running at just under 2%.

But these numbers from Bayer also point to my core concern – that many blue chip German equities are fairly valued at best, and over valued at worst. The price to earnings ratio based on 2015 estimates for Bayer is a mighty 24, falling to 19.6 times 2016 estimates. Bayer may well be a world class giant but its shares certainly aren’t cheap! 


Overall the DAX currently trades at around 14.4 times estimated earnings, a seven-month low relative to the broader European market although that PE ratio is above average for the last five years. The dividend yield on the DAX is currently around 2.8% per annum. The next table below from DAX pulls together key fundamentals for the index and shows that based on trailing earnings (reported profits) German equities trade at just under 18 times profits.


 Bulls jump on these numbers and then cite charts such as the one below – from Yardeni’s website again. It shows longer term valuation measures for the DAX index back to 1995. Back in the 1990s DAX stocks were trading at well above 20 times earnings, thus making the current forward PE ratio of between 13 (Yardeni’s estimate) and 14 (market consensus estimates) very reasonable. But I’d argue that the first/left half of this chart is almost entirelyirrelevant – German and Europe was a very different place all those years ago and Germany has undergone profound structural change. The better starting for any sensible analysis in my humble opinion is the beginning of this century, for the period starting 2002. If we rebacse around this starting position – post unification, post the Euro – we see that the current PE ratio is slap bang in the middle of what we’d expect, if not in the top quartile.


 My Bottom Line?


In the short term I suspect that a concerted push above 12,000 for the DAX index is possible if there is positive momentum following a resolution for the Greek crisis. A great wall of money is looking to get to work in European equities post-Greek crisis and much of it will find its way into blue chip German equities. We might even be slightly under-estimating the corporate profitability led rebound in local equities and on this subject I wouldn’t be surprised to see the earnings growth rate in the DAX stocks push above 15% in 2016.

But this momentum driven push higher – which assumes some form of positive outcome to the Greek affair – will simply make German equities seem even more expensive. My own sense is that the smarter investor should consider taking profits from German shares to invest in Europe’s periphery, such as Spain and Italy. I don’t doubt that the German economy will gain speed as 2015 develops but any rise in the German DAX will be limited by the index’s high valuation and a margin squeeze.

This last phenomena is exactly what’s needed for the wider Eurozone economy –German exporters will see their profit margins tighten as local workers start to demand higher wages. Labour unrest is already on the increase in Germany and to rebalance the Eurozone economy we desperately need German consumers/workers to spend more. Given the German’s well known reluctance to borrow, that means a consumer recovery must be funded by increased wages which must in turn eat into corporate profitability.

I would contend that if the Eurozone does stage a strong recovery in the remainder of 2015 – probable though by no means certain –the rebound will largely be ‘domestic’ in nature i.e driven by surging consumer demand in France and Italy. If I’m right that doesn’t necessarily mean that exports from Germany will shoot up in a Eurozone recovery. Investors in places such as France and Italy by contrast will benefit from looser fiscal policies, significant money injection, and the growing momentum towards structural reform. Given German equity valuations I’d be looking west and south for more adventurous equity alternatives. 


The content of Asset Allocator is provided by David Stevenson, an independent financial journalist. The views expressed in this page are those of David Stevenson only, and Societe Generale takes no responsibility for his views. The views expressed are David Stevenson's views as of the date of publication only. Neither David Stevenson nor Societe Generale accepts any liability arising from investment decisions you may make for your own account. This material is intended to give general information only and is not to be construed as investment advice. The investments mentioned may not be suitable for everybody and you should ensure that you fully understand the investment you intend to make before making an investment. Links to external websites are not operated by or affiliated with Societe Generale. While we aim to point you to useful external websites, we cannot be responsible for their content or accuracy. Societe Generale takes  responsibility for the views expressed on any external websites or any liability arising from investment decisions you may make. You should seek professional advice if any of the content of this page is unclear.


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