Bloomberg News

Germany at Highest Value Prompts Sellers as Europe Mends

July 23, 2014

Germany at Highest Value Prompts Sellers as Europe Economy Mends

Industrial production fell for a third month in May and factory orders dropped more than economists had predicted, according to separate reports in July. Photographer: Krisztian Bocsi/Bloomberg

America’s appetite for German stocks is cooling as Europe’s biggest economy shows signs of weakening and its equities hover near record levels.

Traders have pulled (EWG:US) almost $817 million in the past six weeks from a U.S. exchange-traded fund holding German companies, while investing $270 million in an ETF of broader European equities, according to data compiled by Bloomberg. The German benchmark DAX Index rose to a record this month, nearing its highest valuation since 2009. It climbed 0.2 percent today.

While data from Spain to Italy signal an improvement in the economic recovery, German indicators from industrial production to investor confidence have declined. U.S. investors betting on a euro-area resurgence may be moving funds into peripheral markets, after the DAX almost tripled from its low in 2009, according to Todd Lowenstein of Highmark Capital Management Inc.

“We’re seeing some rotation out of German stocks because there’s been some slowdown in the economy relative to some others in Europe,” Lowenstein, who helps manage $16 billion at Highmark Capital Management in Los Angeles, said in a phone interview. “We’re seeing strength in the periphery. When you hit record highs as the DAX has done, investors will punish you if you don’t deliver on their high expectations.”

The German equity index climbed above 10,000 for the first time ever last month and reached a record 10,029.43 on July 3. It has declined 2.9 percent since then as concern grew over the Ukraine crisis.

Economic Reports

German investor confidence declined for a seventh straight month in July, missing economist projections. Industrial production fell for a third month in May and factory orders dropped more than economists had predicted, according to separate reports in July.

That contrasts with Spain, where a purchasing managers’ index of manufacturing rose in June more than forecast, as retail sales and industrial output improved in May. Retail sales also increased in Italy in April, the latest available figures, and in Portugal in May.

The DAX rallied as investors sought safer stocks during the euro area’s sovereign-debt crisis and bet that Germany’s export-oriented companies would benefit from global growth. While the index surged more than 25 percent in each of the past two years, it’s gained only 1.9 percent in 2014, lagging behind the 10 percent jump for Italy’s FTSE MIB Index and the 7.4 percent increase in Spain’s IBEX 35 Index. (IBEX) The Stoxx Europe 600 Index has climbed 4.3 percent this year.

The gauge of German stocks trades at 13.7 times estimated earnings and its valuation reached 14.1 on July 3, near the highest since December 2009, data compiled by Bloomberg show. It had an average multiple of 11.9 in the past five years.

Peripheral Markets

Even after this year’s advance, the Spanish equity gauge is 50 percent away from its 2007 peak, while the Italian measure and Portugal’s PSI 20 Index (PSI20) would each have to more than double to recover their highs of that year. Greece’s ASE Index would have to more than quadruple to match its 2007 top.

American investors are willing to gamble on riskier assets in the euro region as they seek better valuations outside their home markets and expect the European Central Bank to continue supporting the economy, according to Raiffeisen Capital Management’s Herbert Perus.

The ECB introduced a negative deposit rate in June as it announced new long-term refinancing operations and said officials will start work on an asset-purchase plan. President Mario Draghi also indicated the central bank’s willingness to do more if necessary.

European ETF

The number of shares outstanding on the Vanguard FTSE Europe ETF (VGK:US) climbed to a record 289 million this month, while it fell to 161 million for the iShares MSCI Germany ETF, the least in more than a year, data compiled by Bloomberg show. Traders have pulled almost $1.2 billion (EWG:US) from the German fund in 2014, after investing in it for the past five years, according to the data. They’ve added or kept money in the European ETF every week but two since April 2013.

“U.S. investors are seeking to diversify out of their own market because the valuations got too stretched,” Perus, who helps oversee $36 billion as head of equities at Raiffeisen, said by phone from Vienna. “Europe is fundamentally cheaper than the U.S. Investors may be counting on the ECB to keep supporting the EU, especially the periphery countries.”

The Standard & Poor’s 500 Index trades at 16.6 times estimated earnings, data compiled by Bloomberg show. That compares with 15.5 for the Stoxx 600.

Earnings Growth

At the same time, analysts estimate earnings growth for U.S. companies will be smaller than for European ones. Profit will climb 11 percent for those on the S&P 500 in 2015, compared with a 14 percent gain for the DAX, according to the average projection compiled by Bloomberg. Those listed on the PSI 20 will see a 43 percent jump in earnings next year, while they will rise 21 percent for the IBEX 35 and 25 percent for the FTSE MIB, the data show.

Investors will probably return to German stocks when the tension between Ukraine and Russia eases, according to Ofi Gestion Privee’s Jacques Porta. The DAX lost 2.5 percent in the three days through July 21 as the U.S. and the European Union imposed further sanctions on Russia and a Malaysian jet carrying 298 people went down in an attack that Ukraine’s government blames on pro-Russian rebels.

Germany has the strongest trade ties with Ukraine and Russia among western-European countries, according to data from the International Monetary Fund.

Ukraine Crisis

“German stocks have underperformed the broader market this year mainly because of tensions between Ukraine and Russia, but this is a short-term effect,” said Porta, who helps oversee $780 million from Paris. “Investors will buy into Germany again because the German economy and companies are the most efficient and competitive within the euro zone. I’m skeptical that the German ETF will continue to widen the gap with Europe.”

The German ETF holds companies (EWG:US) from drugmaker Bayer AG to Deutsche Bank AG and carmaker Daimler AG. The European fund has companies such as France’s Total SA, Banco Santander SA in Spain and Belgian brewer Anheuser-Busch InBev NV.

U.S. investors seeking greater returns may continue increasing their holdings of equities in peripheral Europe at the expense of German stocks, according to Wasif Latif, the vice president of equity investments at USAA Investments.

Shrugging Off

While the Stoxx 600 sank the most since March in the week ended July 11 amid fears that financial problems with Portugal’s Espirito Santo Financial Group SA would spread, U.S. investors shrugged off fears of a potential resurgence of the European debt crisis. They added (EWI:US) almost $100 million in the iShares MSCI Italy Capped ETF in the last two weeks, while they maintained assets in the iShares MSCI Spain Capped ETF, according to data compiled by Bloomberg.

“As the euro zone has seen recovery, and with the ECB showing they are ready to provide support, investors may be thinking that they don’t need to be as concerned with being safe with high-quality German investments,” Latif, whose firm oversees $61 billion, said by phone. “Countries like Spain, Italy and Portugal are more attractive for those kinds of higher-risk investors.”

To contact the reporters on this story: Namitha Jagadeesh in London at njagadeesh@bloomberg.net; Anna Hirtenstein in London at ahirtenstein@bloomberg.net

To contact the editors responsible for this story: Cecile Vannucci at cvannucci1@bloomberg.net Alan Soughley


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Companies Mentioned

  • EWG
    (iShares MSCI Germany ETF)
    • $28.9 USD
    • 0.30
    • 1.04%
  • VGK
    (Vanguard FTSE Europe ETF)
    • $55.72 USD
    • 0.22
    • 0.39%
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