Model check

(Reading time: 3 - 6 minutes)

Logo pw2For 16 years, the stock market indicator of private wealth has been providing valuable information for investors in the German stock market. Since many members of our network have asked about the background to this model, we are happy to explain how we work.

The editorial staff regularly informs its readers about the current signals of the in-house stock market indicator. What is behind this model?

In principle, it is a matter of finding out when the relationship between opportunity and risk in equity investments is positive in the medium to long term. Und when not.

The editorial team uses zwei Indikatoren. First, share purchases are interesting when the overall market is favourably valued. And they are risky if the market is highly valued. Second, equity investments are promising if the economy and thus corporate earnings are expected to improve. And they are less lucrative if the economy and earnings are expected to deteriorate.

The first question - is the market cheap or expensive? - is answered by the editors using a long-term trend model that incorporates a broad cross-section of economic data. The private-wealth trend model thus reflects a kind of "fair value" of the DAX in the light of long-term economic developments. A comparison with current quotations then shows whether the market is cheap or expensive.

A favourable valuation means that investors can expect higher returns in the long term than the long-term average of 6-8 percent.

A high valuation reduces the long-term earnings potential and makes the market vulnerable to setbacks.

The answer to the second question - how is the economy developing? - is provided by the monthly survey on the business climate conducted by the Munich-based ifo Institute. The researchers ask around 10,000 entrepreneurs about their business expectations for the next six months. If expectations fell three times in a row after a previous increase or rose three times in a row after a downturn, the ifo Institute sees this as the beginning of a new long-term trend.

In the past, turning points in the economy could thus be predicted well. After all, those at the helm know best where the wind is blowing from.

So the strategy is: It is advisable to be heavily invested in equities when the DAX is below its fair value AND ifo business expectations indicate a positive economic turnaround. Equity exposure and thus the risk should be significantly reduced if the DAX is above its fair value AND the ifo business expectations signal a downturn.

However, both indicators do not always give the same signals. If, for example, the stock market is favourably valued and economic researchers are becoming sceptical, it seems sensible to reduce the equity quota, but not to sell everything. On the other hand, an upward economic turnaround in an expensive stock market would be a signal to build up the equity ratio without going full throttle.

The private-wealth stock market indicator therefore indicates ranges for the equity allocation that appear reasonable given the respective combination of both factors.

In the recent market turbulence, however, the ifo Institute's survey on business expectations has not functioned as a signal generator. The economic slump simply came too quickly. The ifo Institute commented on March 19: "There has never been a stronger decline in the united Germany. The decline in expectations is historically unique in view of 70 years of surveys in the industry.

Given this momentum, it seemed appropriate to set the economic indicator directly to "red" without waiting for expectations to fall three times.

At the same time, however, in the week of publication of the ifo data, the valuation of the DAX had also improved massively. On 19.3, the German stock barometer was only at around 8500 points. At this level, the DAX was only at around 70 percent of its fair value.

In this constellation - favourable valuation, red economic light - the stock market indicator advised an equity ratio between 30 and 70 percent. In concrete terms, this meant that in this phase, strategically 30 to 70 percent of the capital earmarked for equity investments should actually be invested.

For example, if you have planned to invest 50 percent of your assets in equities in your strategic asset allocation, you should now actually have invested between 15 and 35 percent in the equity market according to the indicator.

We use the results of the capital market seismograph for a more precise, short-term equity positioning within this range. The seismograph is a kind of weather forecast for the stock market. Using a complex mathematical model that includes both economic variables and direct market indicators, the model estimates the probability of three market conditions in the coming month. Green" means that a calm market with a positive trend is expected. If the probability of "green" is very high, investors can invest with confidence. "Yellow" indicates a turbulent market with positive expectations - investing is okay, but hedging is indicated. And "red" indicates a turbulent market with negative expectations. The advice is then: Do not invest.

At the beginning of the second week of March, the capital market seismograph recommended a significant reduction in the equity ratio. At the time, Oliver Schlick, Secaro, - who developed the model together with Professor Rudi Zagst from the Technical University of Munich - commented on the massive increase in the probability of negative turbulence that was evident at the time as follows: "Against this background, investing in equities is simply too risky. That is why a significant reduction in the equity ratio is recommended".

This has not changed at present. "The probability of negatively turbulent markets continues to dominate events, so from the seismograph's point of view there is currently no reason to deviate from the very defensive weighting of the stock market in the portfolio," Oliver Schlick informs.

In combination with the two factors of the private wealth stock market indicator, this means that the short-term recommended equity weighting remains at the lower end of the medium-term corridor of 30 to 70 percent. In concrete terms, as of today only 30 percent of the capital earmarked for equity investments should be invested. 70 percent remains in cash as liquidity. It will now be interesting to see when the seismograph gives the all-clear again and thus allows the private wealth stock market indicator to increase the equity ratio again.


Klaus Meitinger

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

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