Stock market jitters

Plenty of Cash Against a Crash

ARCHIV - Händler sitzen unter der DAX-Anzeigetafel am 05.06.2014 auf dem Parkett der Deutschen Börse in Frankfurt am Main. Foto: Boris Roessler/dpa (zu dpa "Dax startet Stabilisierungsversuch" vom 10.02.2016) +++(c) dpa - Bildfunk+++
The merged Frankfurt and London stock exchanges could be based in the Netherlands to end a Brexit-induced impasse that threatens the $14.3 billion deal, sources told Bloomberg.
  • Why it matters

    Why it matters

    Record-high cash levels, together with rising corporate earnings, attractive dividends and declining valuations, should protect equities from a deep and prolonged crash.

  • Facts


    • Only 9 percent of professional investors in a German poll said they expected British voters to vote on June 23 to withdraw from the European Union.
    • Germany’s benchmark DAX index is expected to fluctuate widely in the next few quarters, but not to drop below 8,200 points.
    • The relatively high cash positions held by investment funds were last seen in 2012, at the height of the Greek debt crisis, and in 2008, before the Lehman Brothers bankruptcy.
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The stock markets are living up to their reputation of being no place for people with weak nerves.

The DAX, Germany’s benchmark index of the country’s 30 most valuable companies, has lost 10 percent of its value in the last six months, after gaining just as much in the preceding months.

This volatility is more likely to increase than decrease in the months ahead, given political and economic uncertainties such as the U.S. interest rates and presidential elections as well as Britain possibly leaving the European Union.

But worries about a crash, like the one that occurred after the turn of the millennium or when the financial crisis erupted in 2008, seem unfounded.

The possibility of a U.S. interest-rate hike is creating a fair amount of uncertainty. The American central bank, the Federal Reserve, is keeping investors in suspense. For months, Fed President Janet Yellen has kept the markets in the dark over whether the additional steps will soon follow the first rate hike in December.

Because hardly anyone can assess the consequences of a Brexit for the British economy and the financial markets, many investment firms, including Axa Investment, are advising customers not to make any decisions until after June 23.

Arguably, uncertainty stresses the markets more than bad news, as recently reflected in the abrupt price fluctuations in late fall, when Ms. Yellen repeatedly postponed the first rate hike.

The June 23 referendum in Britain on a withdrawal from the European Union, or Brexit, is just as unpredictable. If the anti-E.U. movement succeeds, “a new cold spell would be likely,” DZ Bank said in a report. The bank gives a Brexit a 40 percent likelihood.

Because hardly anyone can assess the consequences of a Brexit for the British economy and the financial markets, many investment firms, including Axa Investment, are advising customers not to make any decisions until after June 23.

Adding to the general uncertainty are the U.S. elections later in the year, with the possibility of the unpredictable Republican candidate Donald Trump becoming president. His slogan “America First” and his protectionist statements threaten to weaken world trade. The fact that the communist North Korean press recently referred to Mr. Trump as a “prudent politician” does little to increase confidence in his leadership.

The markets expect neither a Brexit nor a Trump as president. In a poll of more than 1,000 professional investors conducted by the Sentix research group, only 9 percent of the respondents said they expected a Brexit. “If it happened, it would be a huge negative surprise,” warned equities expert Ralf Zimmermann of Bankhaus Lampe.

Then there’s the global economy, which is only growing at a rate of 3 percent, on the heels of past growth rates of 4 and 5 percent. That growth isn’t enough to ensure that heavily export-focused German companies can consistently increase profits. “The upshot is that the DAX is likely to fluctuate between 8,200 and 11,200 points in the coming quarters,” Mr. Zimmermann said, pointing to the possibility of “new annual lows in the second half of the year.”

But even major skeptics don’t see the DAX falling below 8,200 points. The times when the market was particularly down – most recently in early May – have been followed by abrupt rallies. This is probably attributable to the large cash reserves of major investment funds. Concerned about the many risks that could upset markets, including international terrorism, professional investors have increased their cash reserves.

Bank of America Merrill Lynch conducts a monthly poll of more than 200 fund managers with total managed assets of $600 billion (€525 billion). On average, the funds currently hold 5.5 percent of their assets in cash. That is a significant amount. Similarly high cash levels were noted most recently in 2012, at the height of the Greek debt crisis and in 2008, before the bankruptcy of the Lehman Brothers investment bank. Although high cash levels are still not a sure sign that the available funds will quickly flow into stocks, in the longer term higher prices have consistently followed high cash positions.

Profits are the most important driver of prices in the long term and those of the 30 companies listed on the DAX have increased after going essentially nowhere between 2011 and 2015, a period of high volatility. In the first quarter of 2015, the DAX-listed companies increased their operating earnings by 7 percent to €34.6 billion. According to calculations by auditing firm EY, this is the biggest increase ever in a first quarter. The many industrial companies – excluding banks and insurance companies – achieved a 15-percent gain in earnings, despite the end of the boom in China.

The positive effect of increased earnings are cheaper shares. Based on the surprisingly sharp decline in corporate profits in 2015, shares in the DAX companies were valued at a price-earnings, or P/E, ratio of about 20. This high valuation is now in decline again. On the basis of first-quarter earnings and anticipated earnings for the rest of 2016, the average P/E ratio has declined to 12.7, which is lower than the long-term average of 14.

Equities seem even more attractive when compared with government bonds, which are yielding annual returns of less than 1 percent in Europe. Savings accounts are not yielding any interest at all. This “investment state of emergency” is likely to continue, especially after European Central Bank President Mario Draghi last week promised to maintain low interest rates for some time to come. Now Mr. Draghi is even buying corporate bonds to enable companies to spend and invest more. This move, in turn, is driving down yields.

Most companies pay dividends, which represent ample returns compared to bond yields. Based on current share prices, half of all DAX companies are now paying an annual dividend yield of more than 2 percent, with seven companies even reaching 4 percent. Investors in automaker Daimler and insurers Allianz and Munich Re are earning returns of just over 5 percent. All three companies have almost always increased their distributions in the last five years, and never reduced them.

The bottom line: Enormous risks are reflected in record-high cash levels. These cash levels, together with rising corporate earnings, attractive dividends and declining valuations, ought to protect equities from a deep and prolonged crash.


Ulf Sommer covers companies and financial markets for Handelsblatt. To contact the author:

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