The Munich-based ifo Institute's business climate index fell surprisingly sharply in May. The slump in business expectations in industry, which play a decisive role in the private-wealth stock market indicator, was particularly sharp. This index fell from minus 2.3 points in April to minus 13.6 points now (chart above).

For us, business expectations in industry are so important because they are not only an indicator for the German economy but also for the DAX. In the past, a decline in the index three times after a sustained rise often indicated a downward trend reversal.

At first glance, therefore, the May result is not that dramatic. After all, it is only the first decline after a continuous six-month rise. For a classic sell signal from the ifo indicator, the index would also have to decline again in June and July.

However - and this puzzles us - this slump is unusual for two reasons.

In a normal economic cycle, business expectations in industry move successively from negative to double-digit positive territory. The number of those who expect their business to improve in the next six months is then significantly larger than the number who expect it to worsen. The upswing then usually leads to a boom, which then slowly turns into the next downturn.

This time the upward movement broke off abruptly, although the index was still slightly in negative territory. In the last 30 years, something similar has only happened once - in 2012 - when the Greek debt crisis and thus the euro crisis intensified. This dramatic turnaround is very nicely visible on the ifo business cycle clock.

Even more remarkable is the extent of the decline. In the past, a turnaround in the economy was accompanied by a decline in the expectations index of between 4 and 17 points - over the course of three months. Currently, this magnitude has been reached in only one month. This is worrying. For there is now a big question mark behind the hoped-for recovery of the economy after the technical recession in Germany - two quarters with negative development of the national product.

Our positive basic assessment of the past months has thus been significantly dampened. This has not yet had a negative impact on the long-term equity allocation of the private wealth stock market indicator. However, we now need to be even more vigilant.

In this context, we expect a lot from the capital market seismograph. You know: Within the corridor defined by the economy and the stock market valuation, the results of the capital market seismograph decide on the exact stock ratio of the stock market indicator.

To do this, the seismograph combines various economic variables - early economic indicators, interest rate developments or price fluctuations on the stock markets. From these, the probabilities for three market states in the next month are distilled. Green stands for the expectation of a calm, positive market. If green dominates, investors should invest in shares. Yellow indicates the probability of a turbulent positive market - that means investing, but with a sense of proportion. And red indicates the probability of a turbulent-negative market. In this case, abstinence from equity investments is called for.

Since the beginning of May, "yellow" has reached by far the highest probability values. This increase was almost entirely at the expense of the probability of negative turbulence (red), which amounted to an all-clear. "A clear negative development on the stock market is now no longer to be expected from the seismograph's point of view," informed Oliver Schlick, Secaro, three weeks ago, concluding at the time: "Overall, the probability distribution has arrived in favourable terrain. This justifies raising the equity quota to the maximum permissible level."

According to Schlick, this assessment still applies today. However, the expert now perceives a slight deterioration in the probability landscape for individual indicators. "This is something to watch very closely in order to get off the gas again in time if necessary," says Schlick.

The bottom line:

While the business cycle component of the private-wealth stock market indicator remains positive. However, the extent of the decline in business expectations calls for increased attention.
Because the German stock market is no longer undervalued - the Dax is trading close to its fair value - the strategic corridor of the equity allocation suggested by the model continues to lie between 65 and 95 percent of the individually envisaged equity allocation.
Within this corridor, the results of the capital market seismograph define the exact equity quota. Since the seismograph still suggests a maximum utilisation within this spectrum, the equity quota of the private-wealth stock market indicator remains at 95 percent of the individually intended equity share.

This indication of the individually intended equity share is important to us. Models like the private-wealth stock market indicator can only ever be based on economic data. How high the individual share quota should be in times of war is something each investor must decide on the basis of his or her own risk appetite and risk-bearing capacity.

Yours sincerely,
Klaus Meitinger

Note: Despite careful selection of sources, no liability can be accepted for the accuracy of the content. The information provided in private wealth is for informational purposes and is not an invitation to buy or sell securities.
For a more detailed explanation of the private wealth stock market indicator, please read "News from the editorial office - strategic buy signal for German stocks" of 25 January 2023.