Is There A Case For German Equities?January 27, 2015
With the highest productivity in Europe, a sizeable current account surplus and rock bottom interest rates, is there a case to made for German equities? Germany’s competitiveness, export performance and trade surplus should increase as the Euro weakens helping German exporters in markets outside of the Euro bloc.
Let’s start with a few details to set the context. First, let’s look at the composition of the German stock market. Our table below shows the number of companies in each sector in the MSCI Germany index and then the next table shows the percentage of companies in each sector.
MSCI Germany – Number Of Companies In Each Sector
MSCI Germany – Percentage Allocation By Sector
We can divide the MSCI Germany index into two broad segments–cyclicals (consumer discretionary, financials, materials, industrials, information technology) and counter-cyclicals (health care, consumer staples, utilities and telecom). Roughly 75% of the companies in the MSCI Germany index are cyclicals, while counter-cyclicals are roughly 25% of the index. Late cyclicals (materials, industrials….Germany has no energy companies in the MSCI Germany index) are roughly 30% of the index. Growth counter-cyclicals (health care and staples) are just under 19% of the index.
Next let’s describe how cyclicals and counter-cyclicals have been performing in Europe. Over the last ten years, MSCI Europe cyclicals have significantly underperformed the MSCI World index. In the chart below, we show the relative performance of MSCI Europe cyclicals vs. counter-cyclicals compared to 10 year German Bund yields. Cyclicals have underperformed counter-cyclicals by 46% over the last 10 years as German yields have collapsed to 35bps.
Over the last five years, the relative underperformance of European cyclicals can also be considered against the USD. Strength in the USD (red line, inverse, right scale) is highly correlated to the relative performance of cyclcials (blue line, left scale).
Late cyclicals in particular are very highly correlated (88%) to movements in German yields.
So, it’s fair to say that based recent experience, a falling Euro and falling rates in Europe are a bad combination for European cyclicals. On the other hand, these things are good for the relative performance of European counter-cyclicals. In the charts below, we show the relative performance of counter-cyclicals vs. cyclicals compared to German rates.
The relative performance of counter-cyclcials vs. cyclicals has recently broken out to new highs. Counter-cyclicals have outperformed by 33% over the last five years. Drilling down to the growth counter-cyclicals, the same observation holds. Growth counter-cyclicals have outperformed cyclicals by 65% over the last five years.
1) Only 25% of the MSCI Germany index are counter-cyclicals
2) Counter-cyclicals relative outperformance is highly correlated to the Euro and German rates
3) Counter-cyclicals have significantly outperformed over the last 5-10 years
4) Likely, if the Euro continues to fall and German rates continue to fall, counter-cyclicals should continue to outperform
Now, lets take a look at a group of German companies to see what we have to pick from. Our investment strategies are based on the concept that companies that spend huge amounts of money on intangible forms of capital are systematically mis-understood in the marketplace due to conservative accounting standards that compel these companies to expense their intangible investments. So, we’ll focus on the German companies inside of our Gavekal Knowledge Leaders Developed World Index (link for more information).
Gavekal Knowledge Leaders Developed World Index – German Companies