Can the resilience of German equity markets continue despite the headwinds still facing the European economy?
While most European stocks plummeted earlier this year amid fears of a sovereign debt crisis in some peripheral countries, the German market remained flat.
At the end of May, Madrid’s IBEX index had lost 22% in the year while the German DAX was only down 2.2%, even outperforming the S&P 500 index, which was down 3.9%.
As German confidence continues to swell, European fund managers have been taking advantage of this ‘boom’ period, with many heavily weighted to the region.
But why has Germany performed so well compared to its eurozone peers and is this outperformance set to continue?
Raj Shant, portfolio manager of the Newton European Higher Income fund, believes Germany’s success will persist thanks to the country’s position as a leading world exporter. His fund is heavily invested in the region, with a 21.5% allocation.
“Per head of population the German export machine is the most successful export machine the planet has ever seen,” he says.
Until it was overtaken by China last year, Germany was the world’s top exporter. The two countries combined contributed to $1.9trn of world exports in 2009.
History
Germany’s long history of having a progressive value-added mindset, which previously allowed it to cope with a strong currency and high labour costs, has also helped it stay competitive, Shant adds.
When the country reunified, it did so at a one-for-one exchange rate with the East German mark – the Ostmark. This undermined the economy for most of the 1990s.
By the end of the decade Germany had an inefficient and uncompetitive economy and so there was a collective agreement between employers and unions to cut salaries rather than lose jobs.
This dropped the cost of production substantially and has contributed to German exports being so successful over recent years.
Shant believes these “engrained” qualities coupled with increased export demands from newly industrialising countries such as Brazil, China and India will allow Germany to stand up well compared to other European companies.
“When these industrialising countries are building new infrastructure and new capacity, they want German machinery,” he says.
The manager also believes the sovereign debt crisis benefited Germany: “The more talk there was or is about Greece and Portugal’s problems, the better it is for Germany. Anything that keeps the economy weak favours the German economy because Germany is the biggest beneficiary of the falling euro,” he says.
Management
Shant holds various German stocks including engineers, media companies and retail firms. He stays clear of German banks, however, gaining exposure to financials through insurance companies.
“Given how well the country is run and how careful the government is when it comes to spending, it is amazing how badly managed the financial sector is,” he says.
Meanwhile, Hugh Cuthbert, manager of SVM’s Continental Europe fund, is also overweight Germany with just under a third of his portfolio allocated to the region.
“If you look at Europe in general, you have interest rates that are low, a currency on its knees, and markets that are very cheap because of the sovereign debt crisis.
“But Germany has no difficulties with public finances, world leading companies that do not need to sell to troubled European countries and a strong manufacturing base,” he says.
Cuthbert also agrees a weak euro is positive for Germany.
“The currency and interest rate environment in Germany is too low considering the outlook is good but that’s manna from heaven for investors and companies,” he adds.
He says if Germany were a country in isolation, the currency would be higher, interest rates would be higher and capital would be more expensive and more difficult to export.
Cuthbert holds a mixture of small-, mid- and large-cap stocks. His largest holding is Bertrandt, which provides consulting services to the automotive industry.
Examples
He says: “This is a prime example of what is happening in Germany. The stock is on a p/e multiple of about 8x, it has about 25% of market cap in cash and it has earnings visibility of at least two years. They are also looking to employ 500 people.
“Valuations in this case are almost laughable. If you deduct cash from the market cap it is probably on a P/E of 6x which is crazily cheap.”
He also likes Tag Immobilien, a property company. It is trading at a 40% discount to NAV compared to UK companies that are trading at a 10%-15% discount.
The one area he would avoid is the renewable energy sector. “There are a lot of solar companies out there thanks to some beneficial grants in the solar market which have come under pressure as budget pressures have hit the public purse. They have got way too expensive,” he warns.
Despite the region’s success so far this year, Argonaut Capital’s Oliver Russ is not as bullish for the second half of the year.
He says although things are going well a lot of factors have already been priced in and as Germany’s markets are predominantly industrial, if there is a double dip the country could suffer.
For the first half of year, he says, Germany was definitely the thing to own.
Conservatism
“Fiscally it is conservative, so it does not have a huge deficit and it benefits from flight to quality names. German Bunds have really come in this year – at the moment they are yielding just 2.5%.
“Exports are also booming and imports are returning to normal, suggesting there is some sort of domestic recovery happening,” he says.
That Germany is a manufacturing economy and benefits from growth in emerging markets is also positive.
Although Germany has had all these factors going for it so far this year, some may not be so favourable in the second half of the year, Russ believes.
“The euro has firmed a bit over the last couple of months so exports aren’t as competitive as they were and places like Spain and peripheral countries are very oversold so the performance differential has narrowed considerably since early June.”
But Germany is still the second largest holding in terms of region in the £376.7m Ignis Argonaut European Income fund.
Russ holds Deutsche EuroShop, a shopping centre owning company; BASF, the world’s largest chemical company which he says is a nice play on recovery; Deutsche Post, a play on global growth and trade; and Munich Re and Allianz.
He is not positive about car stocks believing earnings momentum will probably weaken from here on in for carmakers.
