With the necessary steps for the conclusion of the Greece bailout falling into place (kicking the can down the road for three years, it appears), attention turns to the prospects for other Eurozone economies and equity markets. In this note we focus on Germany, which is the dominant economy in the Eurozone.
Following weak performance in the first quarter, the recovery in the German economy has regained momentum in recent months. The June Markit Composite Purchasing Managers Index (PMI), which covers both the manufacturing (30.7% of GDP) and services (68.6% of GDP) sectors, indicated that German economic growth accelerated, hitting a two-month high. The June Manufacturing PMI revealed an acceleration in production and stronger growth in new orders, including new export orders. It is important to note that exports account for some 50% of Germany’s GDP. The weak euro, therefore, has been particularly beneficial to Germany, with exports adding another strong gain in May, following the healthy gains of the previous three months.
Looking forward, the latest Markit German Business Outlook Survey, based on June data, showed that German businesses remain decidedly optimistic about prospects for the next twelve months, although there was a slight drop from the previous survey, perhaps due to the ongoing Greek crisis. Firms expect to continue their strong hiring trend of recent months and to increase their pace of capital expenditure. They project a 20% increase in profits over the next 12 months. We also foresee a broadening of the recovery in the second half, with consumption, investment (including stockbuilding), and exports all contributing. Economic growth for the year 2015 is projected at 2%, with similar growth in 2016.
In addition to this favorable macroeconomic setting for German firms, equity markets in the Eurozone should benefit from low interest rates, which are expected to stay close to current levels due to the European Central Bank’s continuing its relatively accommodative monetary policy. Germany’s equity market also looks attractive from a valuation point of view. The consensus estimate of the price/equity ratio (P/E) for the DAX is 13.8, compared with 15.2 for the CAC 40 (France) and 15.4 for the IBEX 35 (Spain). (For the S&P 500 the consensus estimate for the 2015 P/E is 17.3.) Earnings growth in Germany is also expected to be strong, projected at 12.8% for the firms in the DAX this year and 9.6% in 2016.
The case for hedging investments in Germany to protect against further euro depreciation against the US dollar looks strong for the second half, despite the experience in the second quarter, when such hedges hurt performance. The difference in the monetary policies of the ECB and the Federal Reserve is expected to drive the euro/greenback ratio down towards parity, perhaps by early 2016. In Cumberland Advisors’ International and Global ETF Portfolios, we are using the iShares Currency Hedged MSCI Germany (NYSE:HEWG), which is up 18.10% year-to-date through July 16. In comparison, the unhedged iShares MSCI Germany (ARCA:EWG), is up only 7.64% over the same period.