The Strategist

All-time high meets recession

Last month, Germany’s best-known stock index hit a new record high. The DAX, which includes the 40 largest German companies, reached a new record of 16,331.94 points on May 19, beating the previous high of 16,291.19 set in the fourth quarter of 2021. Some analysts immediately spoke of a “fake” record as the DAX is a performance index (i.e., it includes dividend payments) and not a price index such as the S&P 500 or the Swiss Market Index (SMI), which track the price movements of the index components without dividend payments.

Thomas Wille
Temps de lecture
8 minutes
German flag
© Shutterstock

In our view, calling the DAX’s recent all-time high a “fake” is not tenable. Today, dividend payments are an integral part of an investment's return potential, not just its price performance. Analysts and investors should always look at the total package - including price potential and dividend yield.

Recession in Germany

On 25 May, just six days after the DAX set the all-time high, the news came that Germany was in a recession, albeit a mild one. Officially, a recession occurs when gross domestic product (GDP) is negative for two consecutive quarters. With a contraction of 0.5% in the fourth quarter of 2022 and another contraction of 0.3% in the first quarter of 2023, this was the case in Europe's largest economy.

However, we should not allow ourselves to get carried away, as extremely weak growth was already expected and the difference between -0.3% and +0.1% growth is hardly noticeable for consumers and investors. Moreover, German GDP fell by 6.9% during the Great Financial Crisis and by more than 10% during the recession following the outbreak of Covid-19. Nevertheless, the situation is still uncomfortable given the weak growth prospects.

A conundrum? - not really

Investors might naturally ask how such a constellation - record high stock prices and a recession - is possible. It would be too easy to say that the stock market does not always accurately reflect the economy, or that equity markets are one of the best leading indicators. That is true to a certain extent, but in this particular case it is too simplistic.

From our point of view, the main factor is that investors' expectations six to nine months ago were much worse than today's actual conditions. As winter approached in autumn 2022, investors did not know that it will be a mild winter or that gas prices would fall by more than 90%. These worst-case scenarios have been priced out of markets. The price gains of recent months have largely been based on the mantra that less bad is good. This was also one of the reasons why we upgraded European equities to "neutral" at the end of the first quarter.

So where do we go from here?

Looking forward to the second half of the year, the road ahead for the DAX and European equities is likely to be bumpier. Another winter is on the horizon and the energy supply challenges are not just limited to Germany. It also remains to be seen whether market participants' current inflation expectations are realistic or whether the core rate will remain stubbornly high, putting pressure on the ECB to raise interest rates well above 4%. In this environment, sector and industry selection is the most important success factor in our view, not only in the German equity market but also globally. The extent to which stock pickers will rise again remains to be seen, but active management will be crucial in the coming quarters.

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