A good acquaintance once said: The long-term prospects of an investment are better the worse it feels at the moment of purchase.

Voila. Here we are. It actually feels very bad to invest more heavily in German stocks at this very moment. The "sick man of Europe" is in recession, the DAX has been trending downward for weeks, and small and mid-cap stocks in particular have lost massive amounts of value.

Nevertheless, the private-wealth stock market indicator gives a first buy signal.

You know: The aim of the stock market indicator is not to precisely identify turning points on the stock markets. Rather, it is intended to help identify phases in which it is more promising than average to invest in equities over the long term.
Specifically, this is always the case when the stock market is favorably valued compared to its history. And when, at the same time, the economy is improving again after a long lean period.

The basic idea is that in an economic downturn or recession, corporate earnings decline. Share prices fall accordingly. Measured against the average earnings potential over an economic cycle, profits and share prices are now low. But this is ignored because investors find it difficult to imagine that a return to old earnings strength is likely in the medium term.
If there is then a turnaround in the economy, reports from the boardrooms initially stabilize. After that, the outlook gradually improves. Profit forecasts go up again - and a new upswing on the stock markets begins.

For this reason, the private-wealth stock market indicator's proposal for the strategic corridor of the share quota is based both on a proven early economic indicator and on the calculation of the fair value of the German stock market.

For the German stock market, the surveys conducted by the Munich-based ifo Institute on business expectations in industry have proven to be an accurate indicator in the past. The rule is: if business expectations improve three times in a row after a sustained decline, the economic component of the private-wealth stock market indicator switches from "red" to "green". In the past, such an event often marked the start of the long journey from the crisis quadrant via the upswing quadrant to the boom quadrant on the ifo business cycle clock (see chart below). For equity investors, this was always a very lucrative journey.

The ifo business climate survey for October is therefore encouraging. "Companies were somewhat more satisfied with current business. Managers were also less pessimistic about the coming month," write the Munich-based economic researchers, concluding: "The German economy sees a silver lining."
Is this the turnaround yet? We took a closer look at the time series on business expectations in industry. In the ifo Institute's monthly survey, participants have a choice of three answer options: They expect their business to be either "more favorable," "unchanged," or "less favorable" over a six-month horizon. The balance value of the business expectations published by the ifo Institute is the difference between the percentages of the answers "more favorable" and "less favorable.

Currently, this index is minus 26.5, meaning that the vast majority of respondents still expect their businesses to develop less favorably over the next six months. However, the trend is moving in the right direction. With the data for the month of October, the ifo Institute also slightly corrected the results of the previous months. The data series now reads - revised - as follows: Continuous decline from April to July 2023 to a level of minus 29.6. In August, the index then remained at minus 29.6 points and finally rose slightly to 29.5 points in September. At this point a month ago, we already surmised: "It would not surprise us if the next movement in expectations were upward. And we concluded, "A significant increase in business expectations in October would be a strong, positive signal in our view and might justify at least loosening the defensive positioning of the private-wealth stock market indicator somewhat."

That is precisely the development that has now occurred. Business expectations in industry improved significantly in October from minus 29.5 to minus 26.5 points.

Sentiment in the German export industry has also brightened slightly recently. The export expectations surveyed by the ifo Institute are also no longer quite so negative. The relevant index improved in October from minus 10.8 to minus 6.9 points. This also gives hope that the worst will soon be over for German industry.

Strictly speaking, the third increase in business expectations is still missing for a flawless economic buy signal. So far we have seen a sideways movement and two improvements. Nevertheless, in our view it is justified to become a little more offensive in investing in equities today. For the second leg of the stock market indicator - the relationship between the current valuation of the stock market and its "fair value" in the medium term - has also improved significantly recently.

After the price losses of the last few weeks, the DAX is now only trading at about 85 percent of its fair value. The development in the small and medium-sized company sector is particularly remarkable. When the MDAX reached its peak of more than 36,000 points in August 2021, the stock market barometer for medium-sized shares was more than 50 percent too expensive relative to its fair value. Today, the MDAX is once again trading below its fair value. The smaller the stocks, the more pronounced this development.

The second leg of the private wealth stock market indicator - the fair value consideration - therefore also justifies a higher equity ratio. Should the fundamental buy signal of the ifo business expectations be confirmed in the coming month, the strategic corridor for the individually envisaged equity share would be increased from currently 45 to 75 to 75 to 115 percent.

Within this range, the results of the capital market seismograph determine the exact positioning.

As a reminder, the seismograph developed by the Technical University of Munich combines various 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 - 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.
For some time now, the seismograph's probability landscape has been very positive. The probabilities for a positive, calm market and for a positive-turbulent market roughly balance each other out and come to values well above 90 percent overall. The probability of negative turbulence remains low. Consequently, the seismograph considers a full investment to be indicated.

The bottom line:

All three components of the private-wealth stock market indicator now look promising. The economic development in Germany and the current market valuation of the DAX relative to its fair value have improved significantly in the last month. If the fundamental buy signal is confirmed next month, the strategic corridor for the equity allocation would be increased from the current 45 to 75 to 75 to 115 percent at the end of November.
Due to the positive development of business expectations, we consider it appropriate to initially shift the strategic corridor for the equity ratio upwards to values between 60 and 100 percent as a first step.

In view of the full investment quota suggested by the capital market seismograph, the concrete share quota suggested by the stock market indicator is therefore increased to 100 percent of the individually intended share quota.

In concrete terms, this means that those who, based on their individual preferences in the Strategic Allocation of Assets, consider an equity quota of 50 percent to be optimal, should now fully utilise this quota (100 percent of 50 percent).
The private wealth stock market indicator thus abandons the defensive positioning of recent months and is now neutrally weighted in equities. The previously held cash position is invested. It is particularly worthwhile to pay close attention to small-cap stocks.
If the fundamental buy signal of the ifo business expectations is confirmed at the end of November and the seismograph still delivers positive readings then the next step would be to overweight equities.

Yours sincerely,
Klaus Meitinger

Note: Despite careful selection of sources, no liability can be accepted for the accuracy of the content. The information provided on the private wealth homepage is for informational purposes and is not an invitation to buy or sell securities.