Equity investors can feel comfortable with share price performance over the past few years. Corporate earnings have risen worldwide and investors have received a high return on their capital. However, in the immediate future, especially over the next 12 to 18 months, things could get rougher than investors have been used to in recent years. This is mainly because the US economy is likely to lose momentum. In Europe and Germany, economic expansion has in any case not been running at full speed for quite some time. Even though the US Federal Reserve is expected to cut interest rates in 2019 in response to the economic downturn, it is already foreseeable today that our economic forecasts for US growth, the EU and China are no longer tenable due to the growing trade strains.
In our new forecast the recovery of DAX corporate earnings that we previously expected is a thing of the past. Domestic industrial companies‘ purchasing and supply chains are closely interlinked with the global goods flows, so the expanded US tariff regime will inevitably exert a braking effect. To date, we have expected German flagship companies to achieve slight year-on-year earnings growth of around three percent. In view of a tougher US tariff regime in the future, and various other (legacy) building sites such as Brexit and Italy, DAX companies with significant cyclical exposure will now even have to absorb a slight drop in earnings.
Such weak earnings performance would stand in contrast to this year’s very buoyant share price performance. Although this can also be attributed to poor 2018 results, share prices ultimately cannot rise faster than corporate earnings long-term. We assume that in the coming months the DAX companies will have to downgrade their rather optimistic growth assumptions (+6%) in order to realistically reflect the growing burdens on world trade. In particular, earnings expectations for cyclical companies are likely to be downgraded at an above-average rate.
A further complicating factor is that equities are no longer cheap by historical standards. The DAX is currently valued at 12.3 (Euro Stoxx 50: 12.7), based on earnings estimates twelve months ahead, and thereby around 9% (11%) above the longer-term average of 11.8 (11.7). In conjunction with excessive earnings expectations, this valuation is historically too high, even if equity markets‘ valuation ratios currently warrant a slight premium to reflect low interest rates and capital market yields.
In the coming twelve months, shareholders will continue to focus on high dividend payments, which are becoming more important in an environment of weak corporate earnings growth. Thanks to dividends, investors receive a fixed income that exceeds the interest rate on bonds to a greater extent than has been the case for a long time – which at least compensates for the wait for better economic times.
Due to continuing political uncertainties and the associated growth slowdown, we are revising our equity market outlook for the DAX and the Euro Stoxx 50 to 12,200 and 3,450 (previously 13,000 / 3,700) points respectively as of 30 June 2020. For the end of 2019, we expect the two leading indices to reach 11,500 and 3,400 points, compared with 12,000 and 3,600 points respectively. We expect the Euro Stoxx 50 to perform slightly better than the more cyclical DAX.