The German DAX Index has recovered remarkably quickly from the corona slump. Moreover, it’s the best-performing equity market in Europe this year. Germany is benefiting from its pro-active corona approach and the pick-up in economic activity in China, its main export destination, says Christoph Ohme, senior portfolio manager for German equities at asset manager DWS. But German companies now have to live up to investors› expectations.
The current earnings season is dominated by measuring the damage caused by the pandemic in the second quarter. However, investors are looking ahead and have put equity markets sharply higher, anticipating a strong recovery in profits in the second half of this year. The German DAX Index is perhaps the best example of this.
With a fall of almost 40% between mid-February and the end of March, the DAX Index fell faster than almost any other equity market in Europe. This was not surprising given the large exposure to financial services providers and export-oriented sectors such as machine builders, industrials and car manufacturers.
The cyclical nature of many of DAX companies has made the strong recovery of the German stock market all the more striking since then. Until mid-May, the DAX performed more or less in line with the rest of Europe, but over the past two months it has outperformed the broad European equity market significantly. Year-to-date, the DAX records a negative return of only -3.1%. This is much better than the French CAC 40 Index (-15.5%) and even the AEX Index (-5.5%), where ‹corona-proof› companies from sectors such as information technology and consumer staples are much more dominant.
Rotation
‘We’ve seen a rotation of technology stocks to more cyclical, export-related companies in recent weeks,› says Ohme. ‘Germany has a stronger exposure to China than other European countries. The economy there has already started up again, and German exporters are benefiting from this.’
Yet the absolute profit and revenue figures these companies show are still not really approaching the pre-corona era, Ohme acknowledges. ‹But the stock exchanges are trading the future and price in a further rise in profits.’
Safe-haven
Ohme sees another explanation for the German outperformance. Germany wasn’t perfect in managing the Covid-19 crisis, but did better than many other countries. ‘The health care system was better equipped for it, and the size of the German support packages for citizens and businesses also helped,’ the portfolio manager notes.
This vigorous approach to the crisis has strengthened Germany’s attractiveness as a safe-haven for investors. And the DAX has also benefited from this, according to Ohme. ‘The recovery has been boosted by retail investors, although not to the same extent as in the US. And momentum has been so strong that investors have more or less been forced to step in.›
But he doesn’t dare say whether the market recovery will continue. ‘That’s really hard to predict. We will not fall back to the price levels of March or April thanks to the stimulus packages from governments and the ECB. But valuations are no longer cheap, and in the second half of this year investors› earnings expectations must be met,› says Ohme. ‘If that doesn’t happen, or not by enough, or if a second wave of corona infections does occur, I don’t rule out a new market correction.’
Selective
It is now important to be selective, emphasises the fund manager. The DWS Deutschland fund, one of the funds under the responsibility of Ohme, opts for an overweight to stable quality companies. The fund has large positions in ‹corona winners› from the IT sector such as SAP (now the largest company in the DAX Index with a weighting of no less than 10%) and the manufacturer of semiconductors Infineon. Until a few months ago, DWS Deutschland also had an allocation of over 10% to Wirecard, which was hit by a major fraud scandal. In the end, the fund only sold its final positions in the company at the end of June. Ohme declined to answer any questions on DWS›s investments in Wirecard.
Ohme, however, does want to say something about the opportunities he sees in real estate companies, and in particular in residential real estate that has proved to be immune to the corona crisis. ‘German real estate stocks have performed very strongly, although it is fair to say that we missed this rally because we thought prices had risen too much in the past,’ he acknowledges.
But this turned out not to be the case, and Ohme now thinks that prices of real estate companies (which represent 4.4% of the DAX index but a larger part of the German Midcap index) could still rise further. ‘Real estate companies benefit a lot from the low interest rates. As a result, they can be satisfied with a lower return on investment. So we will continue to monitor this sector.’
A final sector in which Ohme sees prospects is specialty chemicals, in which Bayer and BASF, among others, are active. Bayer is the third largest position in the German fund, and the fund also owns BASF. ‘We prefer specialty chemicals to bulk chemicals, a cyclical sector with low margins and a lot of competition from China,’ he says.
In general, Ohme is also a little wary of cyclical equities because of the uncertain economic outlook. We have to be very selective here because there are no clear bargains anymore. We were already underweight car manufacturers before corona because of the structural challenges that the sector faces in connection with the switch to electric driving, and of course this crisis has not changed that.›