Ever since Mario Draghi, head of the European Central Bank, hinted at tightening monetary policy last month, Germany’s blue-chip DAX index seems to have lost its mojo. The prospect of rising interest rates, and of the ECB curbing its billion-dollar quantitative easing program – a monthly purchase of mainly sovereign debt the central bank started in 2015 – threatens to spoil an eight-year stint of rising stock prices.
The reason for the dumpy DAX? German bonds may be back in fashion. “Suddenly there’s an alternative to shares again,” said one Frankfurt trader.
Speaking to an audience of students in Sintra, Portugal, on June 27, Mr. Draghi made comments that some interpreted as a sign the central bank would soon curtail, or even discontinue, its aggressive stimulus package. Since then, stock prices of debt-laden companies have crumbled, while those of firms with surplus cash have surged. German bonds, previously snubbed by investors seeking better returns, have also rallied.
Video: German economists ponder interest rates
Granted, bonds are not exactly a lucrative proposition: 10-year German government bonds, known as Bunds, only yield half a percent annually. Still, that’s double the level prevailing before Mr. Draghi’s speech in Sintra, leaving bond investors licking their chops for further gains. Under this scenario, if Germans start snapping up Bunds, it might end the DAX’s stellar run. Changes to the ECB’s expansive monetary policy “are set to increase volatility in the German stock market and specifically to strain share prices of companies with high debt burdens,” said Markus Wallner, an analyst with Commerzbank.
Cheap money tempts consumers and companies alike to spend and borrow more. Net debt among DAX firms has soared from €411 billion ($471 billion) to a record €611 billion ($700 billion) since 2010. Incredibly, this total doesn’t even include banks and insurances, whose liabilities aren’t strictly classified as debt. If interest rates rise, companies will have to pay more to finance their debt, leaving less money to be distributed to investors.
Healthcare firm Fresenius, for example, has accrued €12.9 billion in debt following several multi-billion-dollar takeovers. The purchase of Akorn, an American competitor, cost €4.4 billion in April; last September, Fresenius shelled out another €5.8 billion for Quironsalud, a Spanish hospital operator. Fresenius’ debt ratio – the ratio of total debt to EBITDA, or earnings before interest, taxes, depreciation and amortization – jumped to 2.4.
However, the booby prize in this doubtful competition goes to German utilities group E.ON, whose debt-to-earnings ratio comes in at 4.5, the highest in the DAX. E.ON has been hit by massive write-downs at its spin-off Uniper, spiralling costs at its nuclear operations and pension obligations.
Rising interest rates also mean less profit for these companies. No wonder, then, that RWE’s share price has dropped around 8 percent since Mr. Draghi’s Sintra speech.
But others can benefit from a turnaround in monetary policy. Sports equipment maker Adidas, technology company Infineon, automakers Volkswagen and Daimler, and personal-care conglomerate Beiersdorf aren’t just debt-free – they actually have a cash surplus. Rising interest rates would boost their earnings.
VW and Daimler stock are cheap at the moment. The Dieselgate emissions-cheating scandal not only undermined faith in German carmakers, gasoline and diesel engines are increasingly considered unsustainable. But Daimler just revealed surprisingly strong earnings for the second quarter of 2017, prompting the company to raise its annual profit forecast. Banks and insurances also shine as interest rates rise, because their profit margins widen.
But overall, the DAX’s allure will dim if global interest rates keep rising. The US Federal Reserve Bank has hiked its leading interest rate four times since December 2015, and observers expect at least one more increase this year. And experts at German bank Helaba have shown that on average, the DAX index shrinks by 10 percent in the periods between interest-rate troughs and the peak that follows.
Ulf Sommer covers finance and business news for Handelsblatt. To contact the author: firstname.lastname@example.org