Germany has long been a relative island of stability in the European sea of troubles. Indeed, I’ve advocated for a little over two years that investors overweight the country. In that time, the MSCI Germany Index is up 7.35%, versus the rest of Europe which has inched up 1.41% in that time. In 2012 alone Germany has risen 28%. But now I think it is time to revert to a neutral or benchmark position. Here’s why:
1) Recent signs of a slowdown in the German economy. While Germany remained exceptionally resilient for most of 2012, there is growing evidence that Europe’s troubles are starting to catch up with its largest economy. The most recent reading for German retail sales was a drop of 3.6%. With retail sales collapsing, German consumer discretionary companies, which comprise the biggest weight in the index, may disappoint in the coming quarters.
2) This is not likely to be a one-quarter slowdown. The economic consensus is that German GDP will remain weak, defined as less than 1% growth, for the next several quarters. Our own in-house forecast is even more pessimistic, estimating basically no growth for Q4.
3) Equities are no longer as cheap. Finally, even with a weak economy, we might still be inclined to remain overweight German stocks if the market was as cheap as it was a year ago. But after gaining 28% YTD and 6% QTD Germany is no longer one of the world’s cheapest markets. The price-to-book ratio now stands at 1.53. While this is still cheap compared to the United States, it is up considerably from a year ago, when it was 1.27, and is increasingly expensive compared to other European markets.
To be clear, longer term I still like the fundamentals of Germany, which is distinguished by its world class industrial and export sectors. And I would look to re-enter the market on a pullback, or on signs of stabilization in the German economy. However, in the near-term I would favor taking some profit and adopting a neutral stance on German equities.