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  • Klaus Meitinger

Economic weakness calls for caution.

(Reading time: 3 - 6 minutes)

The economic component of the private wealth stock market indicator is collapsing. It is advisable to reduce the equity quota as a precaution.

The strategic corridor for equity allocation suggested by the private-wealth stock market indicator is determined by two factors - the economic trend and the valuation of the DAX. Basically, the idea is to be more heavily invested in equities when the DAX is low and the German economic traffic light is green at the same time. If the economic outlook deteriorates and/or shares are highly valued, the stock market indicator gradually goes on the defensive.

While the valuation of the Dax - it is trading at about the level of its fair value - need not worry investors, massive headwinds are coming from the economy.

You know: The decisive role in the analysis of the economic trend is played by the monthly survey of business expectations in German industry by the ifo Institute. Participants have a choice of three answers: They expect their business to be either "more favourable", "unchanged" or "less favourable" over a six-month period. The balance value of the business expectations published by the ifo Institute is the difference between the percentages of the answers "more favourable" and "less favourable".

If this indicator worsens three times in a row in industry after a sustained rise, the business cycle component of the private-wealth stock market indicator switches from "green" to "red".

This is exactly what is threatening now. Business expectations in the industrial sector had risen steadily from November 2022 to April 2023. Then, in May, the index surprisingly fell very drastically from minus 2.4 to minus 14.3. We had already pointed out the remarkable extent of the decline a month ago. 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! With a decline of about 12 points, this magnitude was reached in the month of May alone.

This was followed by a further, even sharper decline in June. The Index fell from minus 14.3 to minus 28.1 points.

2306 ifo Chart 1

This is worrying. The ifo data suggest that the hoped-for recovery of the German economy in the second half of 2023 could now fail to materialise. Accordingly, the ifo traffic light is now back on "red".

2306 ifo Chart 2

German industrial companies are now threatened with profit losses after the good results of the past. In the past, the order backlog enabled them to increase sales prices and profit margins. Now the order cushion seems to have been worked off. Ifo writes that many companies now consider their order backlog to be too low. If demand weakens in the future, companies will probably be forced to make price concessions. A decline in the record-high profit margin is then almost inevitable, especially in labour-intensive sectors.

Equity investors should therefore become more cautious. A classic cyclical sell signal of the business cycle component in the private-wealth stock market indicator would require a three-fold decline in business expectations, as outlined above. However, due to the dynamics of the crash, we do not want to wait for the results of the next ifo survey in July. In our view, it justifies reducing the equity exposure already now.

To what extent should this be done?

If the ifo business expectations decline again in July, this would trigger a classic sell signal in the private-wealth stock market indicator. In this case, the strategic corridor for the equity portion would be reduced from currently 65 to 95 percent to only 45 and 75 percent of the individual portfolio portion earmarked for equity investment. In the current situation, we consider it appropriate to implement the first half of this change now and to reduce the equity share to the range between 55 and 85 percent.

Within this corridor, the capital market seismograph decides on the exact allocation. As you know, the seismograph combines various economic variables, some of which are updated on a daily basis - 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 - invest, but with a sense of proportion. And red indicates the probability of a turbulent-negative market. Then abstinence from equity investments is the order of the day.

The seismograph has been positioned offensively for quite some time. And unlike the ifo business climate, the seismograph does not see any storm clouds on the horizon even now. "Yellow, i.e. the probability of a turbulently positive market, still dominates by a wide margin," informs Oliver Schlick, who translates the seismograph's signals into allocation proposals for Secaro GmbH. He continues: "Although the red probability has risen slightly recently, the overall probability landscape of the seismograph still suggests staying fully invested. However, we will be monitoring this very closely."

The bottom line:

With the economic component intact and the DAX valuation close to its fair value, the private-wealth stock market indicator has historically suggested a strategic equity exposure corridor of 65 to 95 per cent of the individual's intended equity allocation. In view of the dramatic crash of the ifo business expectations in industry, this is no longer appropriate. We believe it makes sense to reduce the range to 55 to 85 percent as a first step.

The offensive positioning of the seismograph suggests keeping the actual stock ratio at the maximum of the strategic corridor. The actual share quota suggested by the stock market indicator therefore decreases by 10 percentage points from 95 to 85 percent of the individually envisaged share quota. The cash quota is increased accordingly.

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.

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