MDAX moving from strength to strength – but will this continue?

The MDAX is the shooting star of the DAX index family. The index of 70 medium-weight stocks has been racing from one high to the next over several trading days. The smallest member of the family, the SDAX, has also been trading at record levels, while the leading index itself, the DAX, is still trailing six percentage points behind its all-time high. Based on our outlook for 2017, we expect the DAX to temporarily clear the 12,000 point mark in the course of the year so that the prospects of the all-time high (12,374 points from April 2015) being reached in the near future look altogether good.

In a long-term comparison, the MDAX has outstripped the other DAX indices by far. Since 30.12.1987, the index has gained 11.3% p.a. while the DAX has „only“ reached 8.8% p.a. Thanks to the compound interest effect, the excess return of 2.5% p.a. has put the MDAX today at a level almost double that of the DAX. This serves as further proof of the fact that equity market investors are most successful when they remain invested for very long periods and do not needlessly interrupt the power of the compound interest effect by making transactions and incurring the associated costs and tax payments.

In the point-to-point analysis (today versus 1988), the MDAX has performed far better, but it has not always outperformed the DAX. Particularly during the bubble years of 1997-2000, the MDAX was unable to keep pace with the DAX as it strode ahead. At that time, the MDAX contained too many ‚old economy‘ stocks that lacked the glamour of the DAX superstars like Mannesmann, Deutsche Telekom or Infineon. And this was reflected in the MDAX’s price performance.

If, however, the analysis is based on the entire observation period since 1988, a number of factors can be identified that explain the MDAX’s outperformance.

One main reason for the better performance of the MDAX lies in the problems of the DAX itself. In the past, many heavyweights of the leading index were faced with considerable structural problems that went way beyond the normal cyclical fluctuations of business development. Examples are the crisis of the two listed banks, in particular Deutsche Bank, the realignment of the business models of the two utilities as a direct consequence of the Fukushima catastrophe of 2011, as well as the emissions scandal at Volkswagen. The other index stocks were unable to achieve disproportionately high price gains and thereby compensate the subsequent below-average price development of these one-time ‚bread and butter stocks’, so that the DAX recorded a below-average price development compared with the other German indices.

In addition, the DAX contains by definition the heavyweights of German industry, i.e. companies that have grown strongly in the past and for this reason were added to the index of the largest German enterprises. Examples include car, chemical and industrial stocks. These companies are still expanding today, but they have outgrown their strong growth phases. The mid and small cap indices, by contrast, contain a colourful mixture of companies from a wide range of sectors. Moreover, on average these stocks have a more medium-sized structure and are focused on niche markets in which growth in past years has been visibly higher than in the markets of the DAX companies. Experience shows that companies of this kind are affected to a far lesser degree by negative global political developments (e.g. Brexit, the Trump election) than the DAX heavyweights that do business in all the major markets of the world and are therefore unable to effectively escape any crisis.

Furthermore, the constant addition of innovative-strong companies is one of the key features of the smaller indices. A hallmark of the DAX of past decades has been its great continuity (17 of the 30 founding members are still listed in the index), while reshuffles were more frequently made in the other indices. Take, for example, the MDAX: the index contains only 8 of the original 70 founding members although the index was only launched six years after the DAX.

In a calm trading climate as currently prevalent, we expect the small and mid caps to continue staging a better performance. This is a typical phenomenon of a stock market in an advanced stage of its cycle and is warranted by the higher growth rates. In the meantime, though, a large part of the DAX’s base-induced problems appear to have been worked off, and the DAX heavyweights can also be expected to profit in particular from the current rotation into cyclicals. This could gradually bring the relative underperformance of the DAX to an end.

However, we do not expect trading to remain as stable and calm in the whole of 2017 as it has been in recent weeks. The further trend of prices on all German equity indices will be greatly influenced by political risks this year. The past has shown that the DAX is always more adversely affected by negative political events (e.g. Greece, the Crimea crisis, Brexit). This is attributable in our opinion to the high trading liquidity, particularly in the futures business. According to Deutsche Börse, the DAX is one of the 10 most important underlyings for index derivatives in the world.

In contrast, the small/mid cap indices showed a relatively stable development in the aforementioned crises. We expect this to be repeated again this year. Given the higher valuation (PER 2017e DAX 13.4 versus MDAX 16.3) and the lower dividend yield at MDAX et al, we advise making investments only in the event of a price setback. The DAX, that we have given a ten percent weighting in the DZ BANK Asset Allocation Portfolio, currently appears to be more attractive as an investment instrument than the MDAX.

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