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No Schadenfreude, trade fears dragging German equities down

Wietse Nijenhuis

By Wietse Nijenhuis

Head - Equity Strategy

April 12, 2018

German equities make up almost one-third of MSCI EMU (European Economic and Monetary Union) Index. As such, their poor performance has almost single-handedly pulled the index into negative territory this year. What are the reasons behind their weak showing?

 

The strength of the single European currency might seem an obvious culprit. However, Euro appreciation cannot in fact be blamed. In January, the Euro-US dollar exchange rate was trading at $1.25, with German equities up 7% for the year. Since then the currency has weakened to below $1.23, nevertheless, the German market is down 4.7% in dollar terms. By comparison, European equities are down 1.5% on the same basis.

 

To us, it looks like trade fears are driving the market lower. Four industry groups are responsible for over three-quarters of market’s drop this year: materials, capital goods, pharma & biotechnology and software & services. These sectors are among those that have the highest geographic revenue exposure to the Americas. Companies like BASF, Siemens, Bayer and SAP which derive large shares of their revenues from the US are down between 11%-19% from their January highs in US dollar terms.  Over the last month, the two sectors which have shown the strongest performance, real estate and utilities, derive none of their revenues from outside of the Eurozone.

 

At Citi Private Bank, we have been overweight German equities and of European ex-UK equities as a whole since June 2017. The market tends to perform well during periods of rising global growth, such as we have experienced over the past 18-24 months. We continue to emphasize the strong economic growth backdrop that exists to absorb today’s incipient threats.

 

That said, if several of the world’s largest economies fall into a trap of ever-escalating trade sanctions or self-imposed embargoes, there is a modest probability that global growth will be undermined. In such a scenario, German equities would continue their underperformance. However, that is not our base case. We still assume a positive outlook for the world economy and by extension, for German equities.

 

If trade concerns subside – as we expect them to – German equities’ recent underperformance creates an attractive entry point for investors. The fact that German earnings revisions have remained positive this year reinforces our view.

 

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