Surprising many investors, German equites have been the worst performing major European market even behind the UK since January 2018, which underperformed Europe by 7.2% in 2018 and another 2.3% YTD in 2019. The underperformance has been driven by weak corporate earnings, with its 20 months earnings momentum below the region. Investors key concerns on Germany are broadly related to trade weakness, the potential risks of US car tariffs as well as some temporary domestic issues from new worldwide harmonised light vehicles test procedure (WLTP) emissions standard and low Rhine river water levels to the auto and chemical sector. However, as some of these are short-term issues only, it seems to be the right time for revisiting Germany equities as current valuation are undemanding relative to Europe.
Global demand weakness and trade war outlook would remain the key uncertainties to equity markets at the moment. However, the two transitory factors that weighed on 2018 growth could have presented some upside risk for German equities as they unwind later this year. Firstly, German car production adjustment problem in 2018 due to new WLTP emission standard (0.5% of GDP impact) was almost resolved. Car production volume is picking up recently despite remained below its pre-WLTP level in June 2018. On the other hand, exceptionally low water level in the Rhine river since August 2018 has hindered transport capacity in some German industries and disrupted supply chains of the chemical sector, eventually impact Germany’s GDP growth by around 0.1-0.2% in each of Q3 and Q4 2018, respectively. With water level normalise, production and shipping activities on the Rhine has normalized too. The normalisation of the above two factors is expected to add 0.3-0.4% of Germany’s GDP growth in 2019 and to re-drive its earning momentum.
Besides, Germany is a cyclical play given the sector make-up of the index, which overweight Consumer Discretionary (18.0%), Information Technology (12.5%) and Materials (10.1%) sectors. Within Consumer Discretionary, auto is the key sub-sector, which BMW, Volkswagen, Daimler and the tyre manufacturer – Continental, combined make up 10.8% of the index weight. Indeed, cyclical sectors in Europe are trading at historically cheap valuations relatively to defensives. Its relatively PE is at the trough of the 2012 Euro crisis and broadly in-line with the lows of early 2016. With Eurozone PMIs picked up in February for the first time in six months, this could be an early sign of bottoming out and should bring outperformance for Cyclicals and Germany, given that Germany equities performance has loosely tracked the moves in the Eurozone composite PMI.
Figure 1. Germany sector weights relative to Europe
Source: Thomson Datastream, Noble Apex/iFund
Figure 2. Germany’s performance has loosely tracked with Eurozone composite PMI
Source: Bloomberg, Noble Apex/iFund
To conclude, although the trade risks with the US could weigh on stock prices further in short term, Germany equities are indeed attractively priced on both PB and PE basis. Therefore, adding some world-class German companies or market fund in the portfolio for long-term investment could be a wise decision for investors that can tolerate short-term volatility.
Figure 3. Germany trades at about 10% PE discount to Europe
Source: Bloomberg, Noble Apex/iFund
Funds related to Germany
Barings German Growth Trust Acc EUR
Barings German Growth Trust Acc GBP
Barings German Growth Trust Acc USD Hedged
Fidelity Funds – Germany Fund A EUR
Fidelity Funds – Germany Fund A Acc EUR
Fidelity Funds – Germany Fund A ACC USD (Hedged)
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