For years now, the German economy has been on a strict upward path. But now we see that in the third quarter of 2018, economic performance declined slightly. According to figures from the Federal Statistical Office of Germany (Destatis), gross domestic product (GDP) fell by 0.2 percent compared to the previous quarter – the first quarter-on-quarter decline for more than three years.
Did the stock market once again see this coming? Does the weak stock market possibly indicate a recession is on the horizon? This is unlikely: Many economists remain calm. The Deutsche Bundesbank even gave the official all-clear. It believes that the latest dip in economic growth is due to special effects. “The main reason for the drop is a slump in production in the automobile industry,” explains Jens Weidmann, President of the Deutsche Bundesbank, at an event in Berlin.[1] He expressly warned against reading too much into the decline in GDP. “Fluctuations in figures, both up and down, should not mislead investors: the economic upturn in Germany and the Eurozone remains intact,” believes Weidmann.
Optimistic economists
The German economy is set to experience a strong upturn again by the end of the year. Economists believe that economic growth has slowed somewhat because companies are at maximum capacity and cannot simply produce more. In addition, many companies find it more and more difficult to find the necessary staff.
An economic slump looks different. This is a view shared by many economic research institutes. The Munich-based ifo Institute even raised its growth forecast slightly to 1.9 percent in both 2018 and 2019. “At the moment, we have a strong economy in Germany,” opines ifo economist Timo Wollmershäuser.[2]
The solid economic situation and the continuing extremely low interest rates are likely to leave their mark on German companies, with many of them expected to now expand their business with new investments. “The still favorable financing conditions are encouraging many businesses to make investment decisions, and their high utilization levels suggest an expansion of their production capacities,” explains the economic expert.
Three factors supporting German equities
Even though German equities have been hit hard recently, there are many reasons to be hopeful. This is due to the following three points:
- The continued favorable economic outlook – 1.9 percent economic growth in 2018 and 2019 according to the ifo Institute
- An attractive dividend yield of significantly more than 3 percent
- A favorable valuation by international comparison: At present[3] the average price/earnings ratio of the 30 stocks in the DAX is 12.3. By contrast, stocks in the broad-based US equity S&P 500 index are valued on the exchange at more than 16 times their estimated annual profits generated in 2018.[3]
Favorable valuation also reflected in price/book value ratio
Even if the price of companies is viewed in relation to other indicators, German equities are still extremely cheap. For example, the equities in the MSCI Germany Index (66 equities, which represent approximately 85 percent of the German stock market) are valued at 1.5 times their book value.[4]
To calculate the price/book value ratio, the share price is compared to the value of the equity capital.
By contrast, the MSCI All Country World Index, which replicates the performance of 23 industrialized countries and 24 emerging markets, has a price/book value ratio of 2.1 according to the latest estimates by the Bloomberg financial news agency.
Key figures supporting German equities
It is not only the price/earnings ratio that shows German equities have extremely low valuations. In relation to their book value, German equities are also cheaper than stocks from other parts of the world.
1. Speech at the “Süddeutsche Zeitung – Economic Summit 2018” on November 14, 2018; text: www.bundesbank.de/de/aufgaben/themen/finanzstabilitaetsbericht-767144.
2. www.cesifo-group.de/ifoHome/presse/Pressemitteilungen/Pressemitteilungen-Archiv/2018/Q3/pm-20180906_ifo-Konjunkturprognose.html
3. Source: Bloomberg, as at: November 20, 2018.
4. Sources: Bloomberg, DWS, as at: October 18, 2018. Forecasts are based on assumptions, estimates, opinions, and hypothetical models or analyses that may prove to be inaccurate or incorrect.
