It’s official: after six-and-a-half years of steady gains, the DAX blue-chip index of 30 leading stocks has swung from a bull to a bear market. An upturn is said to be over when the stock market has fallen at least 20 percent, and that has now happened.
Since April, the DAX has lost as much as 22 percent, wiping some €250 billion, or $283 billion, off the market capitalization of Germany’s top companies.
Share prices brushed off Western economic sanctions against Russia and fears of a Greek bankruptcy, but weakening growth in China has brought the boom to an end, even though the companies generate more than three quarters of their revenues in Europe and America and only 16 percent in Asia.
“The stock market reaction in the last few weeks isn’t a trend change that will prompt a transition to a bear market.”
With the exception of medical engineering company Fresenius, all DAX companies are more than 10 percent below their highs now, and for 11 of them, the percentage is more than 50 percent (see chart).
“The correction could well intensify again,” said Christian Kahler, an analyst at Germany’s DZ Bank.
Investors aren’t just worried about the market turmoil in China. They’re also bracing themselves for the imminent interest hike by the U.S. Federal Reserve, the first in almost 10 years. The Fed will convene later on Thursday and could announce an increase or give hints if it could happen in the near future.
Nevertheless, even skeptical market watchers like the experienced Mr. Kahler, who analyzed the 2008 market slump and the bursting of the dot-com bubble 15 years ago, don’t expect the downturn to last.
“The stock market reaction in the last few weeks isn’t a trend change that will prompt a transition to a bear market,” Mr. Kahler said. The current decline was heavily influenced by negative market sentiment and wouldn’t last, he said.
Mr. Kahler predicted that the DAX would climb to 11,000 points by the end of the year. Why? Because while share prices have tumbled, the economic fundamentals haven’t. In fact, corporate earnings forecasts have risen.
Analysts have hiked their earnings forecasts for 17 of the 30 DAX companies in the last three months. The biggest upward revisions of more than five percent have been for airline Lufthansa, insurer Munich Re, fertilizer company K + S Group, which is in focus as a takeover candidate by Canada’s PotashCorp, specialty chemicals firm Lanxess and Mercedes maker Daimler.
Overall, the DAX companies are expected to boost their profits by 14 percent this year compared with 2014. That’s an improvement in the outlook from the start of 2015 when profits were seen up eight percent.
The analysts have been following the upbeat forecasts made by the companies themselves. In addition to Lanxess, Fresenius and pharmaceuticals giant Bayer, a total of 56 further companies listed in the DAX, the MDax of 50 slightly smaller companies, the tech sector TecDax and the SDax of small and medium-sized companies have lifted their earnings forecasts, in some cases twice. Tire specialist Continental raised its full-year forecast following its first quarter and then again in August.
All the companies are citing strong sales in the United States and improving sales in Europe. They’re also profiting from the depreciated euro which has made German goods cheaper and more competitive in dollar markets.
Falling share prices combined with increased earnings forecasts are making the companies cheaper. In April, when the DAX was at 12,000, they were valued at 16 times their expected full-year profit. Since then, the price-earnings ratio has fallen to 12.5. That makes the DAX index almost 15 percent less expensive than its long-term average.
Cyclical stocks in particular have become cheaper. The price-earnings ratio of chemicals group BASF fell from 17 to 12, Daimler dropped from 12 to eight and auto giant VW from 10 to just seven.
There’s a further factor rendering stocks more attractive. The expected dividend yield for the DAX has increased to 3.3 percent from 2.5 percent since April. That means that based on current share prices, investors will receive a dividend of 3.3 percent on their capital — assuming the companies end up delivering the payouts currently expected. Given their improved earnings prospects, that looks likely to happen.
“At the levels now reached there are good chances that the DAX will stabilize in the coming weeks,” said Andreas Hürkamp, an analyst at Commerzbank. “We expect a recovery for the fourth quarter.”
Mr. Hürkamp expects the DAX to rise to 11,800 by the end of the year — a respectable rise of 15 percent from current levels. If that happens, German stocks will no longer be looking so cheap.
Markets expect the Federal Open Market Committee, the Federal Reserve’s policy-setting group, to end its near-zero rate policy in the coming months, possibly as soon as today. Investors tend to put purchases on hold pending anticipated rate hikes. But research by a number of investment banks shows they have little to fear. Interest rate hikes only tend to have a negative impact on share prices when there are several of them in succession.
The notion that cyclical stocks are particularly hard hit by rate hikes is also mistaken. They suffer less from the hike than they benefit from the economic upturn that prompted the rate move. So investors are well advised not to postpone investment decisions until after the next central bank meeting or the one after that.
The rate troughs in the last century show that after the start of a turnaround in interest rates, stock markets quickly recover from the first setback. Statistics show that half a year after the first rate hike, the Dow Jones is up three percent from before the hike. Ned Davis Research, a U.S. company, found out that share prices are higher three, six and even 12 months after the upswing in interest rates begins.
But over a period of several quarters, conditions start to get tougher for markets and for the real economy. Higher interest rates tend to hit corporate earnings because they make investments and refinancing costs more expensive. That weighs on share prices too. In addition, higher interest rates make alternative investments such as bonds more attractive.
Since the start of the 1970s, the DAX saw average growth of just 1.2 percent in periods between the first and last U.S. interest rate hike of a cycle. The Dow Jones even fell 2.3 percent in those periods. The upshot is: the longer and the stronger interest rates increase, the bigger the risk of falling share prices.