The ifo business climate survey for July not only puts a big question mark over hopes of an economic recovery in the second half of the year. There is now even the threat of a renewed slide into recession in industry. This has consequences for the investment strategy.

Background: If business expectations in industry deteriorate three times in a row after a sustained upswing, this has often signalled a downward economic trend reversal in the past. In this case, the economic component of the private wealth stock market indicator consistently switches from "green" to "red". This is exactly what could happen at the end of August.

The background: in the ifo Institute's monthly survey, participants have a choice of three possible answers: They expect their business to be either "more favourable", "unchanged" or "less favourable" over the next six months. The balance of the business expectations published by the ifo Institute is calculated as the difference between the percentages of "more favourable" and "less favourable" answers.

From September 2023 to May 2024, business expectations gradually improved from minus 29 to minus 6.4, meaning that managers became increasingly less pessimistic and there was realistic hope that the number of those expecting a more favourable development in the next six months could soon gain the upper hand. This would then probably also have led to an improvement in the earnings situation in the companies.

This hope could now be dashed. After an initial decline in June, business expectations fell further in July and are now at an index level of minus 14.2. A further deterioration in August would fulfil the condition for a negative trend reversal in the economy.

That would be bitter. According to the ifo Institute, the German economy is still in the crisis quadrant (see chart). The attempt to work its way out of this towards the recovery quadrant is now in danger of failing. Instead, the crisis would worsen.

The conclusion for investors:

Economic development in Germany and the market valuation of the DAX define the strategic corridor for the equity allocation of the private wealth stock market indicator.

As the economic component has been "green" since October 2023 and the German stock market is trading at around the level of its fair value, this corridor lies between 70 and 110 per cent.

Within the strategic range, the capital market seismograph determines the exact positioning. The probability landscape of the seismograph has been very positive for some time. The specific equity allocation suggested by the stock market indicator has therefore been at 110 per cent for several months. The indicator was clearly overweighted in equities.

Now could be the time to take a more cautious stance. Strictly speaking, the third decline in the ifo series of figures is still missing for a flawless sell signal in the model. Nevertheless, it could already make sense - with foresight, so to speak - to become more cautious when investing. After all, if the economic turnaround is confirmed in August, this would mean a significant reduction in the equity allocation in the model. In this case, the strategic corridor for the individually planned equity allocation in the private wealth stock market indicator would be drastically reduced from 70 to 110 per cent to between 45 and 75 per cent.

This would be a very big step. In order to cushion the impact - and because the deterioration in the economic environment is a cause for concern - it could make sense to reduce the corridor for the equity allocation to 60 to 90 per cent as a first step.

In concrete terms, this would mean reducing the equity allocation from 110 to 90 per cent. This is because persistently positive signals from the seismograph keep it at the upper end of the strategic range in the overall view of the model.

An example: Anyone who considers an equity allocation of 50 per cent to be optimal based on their individual preferences in the strategic asset allocation could now consider investing only 45 per cent in equities (90 per cent of 50 per cent results in an equity allocation of 45 per cent). The proportion of cash in the portfolio would increase accordingly.

Sincerely,

Yours

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 stock market indicator is for information purposes only and does not constitute an invitation to buy or sell securities.