What Goes Up

  • Why it matters

    Why it matters

    Prospects of tighter European monetary policy stand to rattle stock markets in the fall.

  • Facts


    • Germany’s DAX index nearly reached a record 13,000 points in June, but the rally is surely over. The index almost fell below 12,000 last week.
    • Investors are bracing for volatility, as a rising euro dents corporate earnings and interest rates look set to rise.
    • On the upside, Europe’s economy remains strong and liquidity levels are high, so falling share prices may trigger buying.
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FILE PHOTO: Frankfurt stock exchange building
Frankfurt's stock exchange. Some fair-weather friends of market rallies are preparing to depart. Source: Reuters

Since way back in 2009 – just one year after the subprime mortgage crisis sideswiped the global economy – leading stock markets have looked unstoppable, chasing record after record. In June, Germany’s DAX index of 30 leading stocks stood at more than twice its pre-crisis level, and seemed poised to crack a key threshold at 13,000 points for the first time.

But before traders could toast the moment, the party fizzled. At the end of last week, the DAX slipped perilously close to 12,000, as fears over the euro’s rise in Germany’s export-led economy combined with disappointing second-quarter results to spook investors. Analysts are predicting a turbulent fall.

Just a few months ago, currency strategists were forecasting the euro would crumble to parity against the dollar. Instead, it has leaped to $1.18, a two-and-a-half-year high. Some strategists see the currency reaching $1.20 in the weeks ahead due, at least in part, to waning confidence in President Donald Trump’s ability to deliver promised tax cuts and deregulation to reinvigorate the US economy. Another reason is an expected slowdown in interest-rate hikes by the Federal Reserve.

Export-reliant firms like carmakers and engineering companies are sure to feel the squeeze from the euro’s strength, so corporate earnings are likely to suffer and weigh on stock prices, analysts said. Markus Reinwand, a stock market analyst at Helaba, a German regional bank, suggested many corporate earnings forecasts were exaggerated. “Stocks have moved too far away from the fundamentals,” he said. In both the DAX and the Euro STOXX 50 (which includes 50 blue chips in the euro zone), more earnings forecasts had been lowered than raised recently, he said.

01p28 Eight Years of Upswing-01

Market players had hoped earnings growth in the second half would help offset the overvaluation in stock prices. Those hopes, however, are looking like pipe dreams. In the absence of greater earnings, more realistic valuations will occur when the DAX falls below 12,000, said Mr. Reinwand at Helaba.

Philipp Finter, a senior investment strategist at Sal. Oppenheim, agrees. If the momentum from corporate earnings hopes evaporates completely, the risk of a downward correction will mount, he said. That, combined with a turnaround in European monetary policy, could turn into a dangerous cocktail for stock markets.

Investors in the euro zone need to brace themselves for the beginning of the end of the European Central Bank’s ultra-easy monetary policy. For years, the world’s central banks have flushed cheap money into financial markets. In the meantime, the US Federal Reserve has started hiking interest rates to stave off inflation, and it’s increasingly obvious the ECB’s easy-money policy will soon come to an end, perhaps by terminating its euro-zone bond-buying program. Ulrike Kastens, an economist at Sal. Oppenheim, said the ECB will likely signal an end to quantitative easing in September, when the central bank has access to the latest forecasts for economic growth and inflation.

“Stock markets would come under pressure if the ECB were to decide surprisingly quickly to start the withdrawal from its ultra-easy monetary policy,” said Felix Herrmann, capital market strategist for Germany, Austria and Eastern Europe at BlackRock. Will James, a European stocks specialist at Standard Life Investments in Edinburgh, said sectors that benefit most from low interest rates, such as real estate, would likely be hardest hit by an ECB tightening.

“Stocks have moved too far away from the fundamentals.”

Markus Reinwand, stock market analyst, Helaba

But the consensus is of an actual interest-rate hike coming later. When that happens, all eyes will be on Italy, currently viewed as the sick man of Europe. “At present the lack of structural reform and weak growth [in Italy] are still masked by expansionary monetary policy,” said Ms. Kastens. “But when interest rates rise, the problems posed by Italy’s government debt will be laid bare.” While investors in Italian bonds would be hardest hit, markets in general would become more volatile if Italy’s economic problems worsened in the wake of an ECB tightening, she said.

Geopolitical risks are another risk factor for stocks. “A further escalation in the situation in and around North Korea would be, for example, anything but helpful and would likely provoke a flight into safe havens like German government bonds and out of stocks,” said Mr. Herrmann at BlackRock.

International investors are a tad more skeptical about Europe than they were in June, when US money was pouring into the continent amid hopes of a strong economic recovery. According to the latest monthly survey of global funds by Bank of America Merrill Lynch, investors are holding an above-average percentage of their portfolios – 5 percent – in liquid funds, citing pessimism about the market outlook. Sensing a sea change, fund managers have reduced their abundant holdings in stocks.

But despite all the risks, strategists see some cause for optimism. Jens Wilhelm, a portfolio manager at Union Investment, said a cheery global economic outlook continues to benefit financial markets. “All important economic areas are in a simultaneous upturn,” he noted, pointing to a resurgent performance, in particular, in the euro zone and China.

An awful lot of cash is parked on the sidelines due to a dearth of investment options. When share prices fall, analysts say, these bargain-hunters will be lured out – unless market volatility chases away the remains of a feel-good rally that was, in the final analysis, fundamentally too good to be true.


Anke Rezmer covers investment, while Susanne Schier heads the private investment team, both at Handelsblatt’s Frankfurt office. To contact the authors:,

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