German equities are back to 2005 and that’s good

For German equities, it looks like 2005 all over again, and that’s a good thing.

Investors are punishing the eurozone’s biggest economy unnecessarily, so it may be the time for the brave to take a dip into German stocks.

Some strategists are beginning to see Germany as a good investment destination, despite the nearly 5% drop in the DAX index over the past six months – or maybe because of it.

The ZEW indicator of sentiment on the economy – a monthly survey in which up to 350 financial experts take part – “suggests new investor optimism,” ING analyst Carsten Brzeski said.

The index jumped from -3.6 in October to 34.9 in December.

PMI figures painted a slightly more mixed picture but were also essentially positive. Manufacturing PMI jumped from contraction (49.5) to expansion (51.2), which according to Brzeski indicates that the lower oil prices have finally reached Germany’s powerful industry and are helping.

Services PMI, however, has continued its slide but was still firmly in expansion territory.

Inventory build-up is over and order books are growing again, which has “brightened the outlook for the coming months,” Brzeski said.

“Moreover, the economy should benefit from a special stimulus package: the weaker euro and the sharp drop in energy prices,” he added.

HSBC strategists have recently upgraded German equities to overweight. They note that the price earnings relative – which compares current PE to past PE to see how a stock or index is valued compared to its past performance – is at its lowest level since early 2005.

“A little bit of good news can go a long way from this depressed level and we now see a glimmer of light with relative earnings revisions turning positive,” Robert Parkes, a strategist with HSBC, wrote in a recent report.

If we look at the trend-adjusted PE (TAPE) – a seasonally adjusted earnings multiple used by HSBC researchers for valuation, and which takes into account cyclical factors — German equities look even cheaper, as the ratio is close to a record low.

German equities are undervalued

German equities are undervalued. Source: HSBC research.

Furthermore, Parkes said, Germany trades on a discount of 32% if we look at the 12-month forward PE, “its most extreme level since early 2005.”

And yet Germany has delivered the fastest real earnings growth in Europe in the past 20 years, at 6.3% a year, compared with the European average of 2.6%.

German equities, by contrast, have moved in line with Europe since 1994, outperforming by only 7% over the entire period, which explains why PEs are so low, Parkes noted.

Some of the cheapest German stocks judged by the 12-month forward PE are carmakers BMW and Daimler, chemical company BASF, construction firm Hochtief and engine manufacturer Deutz.

There are also cheap German equities in the financial sector – Deutsche Bank, Commerzbank, Munich Re and Hannover Re are the cheapest. But investors should bear in mind that the whole sector is weighed down by uncertainty about the future burden of regulation.


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