By Rob Smith
Over the past 12 months, German equities have outperformed their European peers, with the DAX returning 25.48% in Euro terms. This compares with a return of 23.3% in euro terms for the MSCI Europe index over the same period.
This has been due in no small part to the continuing strength of the German economy, as its export-led growth model allows German companies to take advantage of overseas demand. Although this approach has been criticised recently by the US and the IMF, it has allowed Germany to ride out the storm of the eurozone crisis and provide a pillar of strength for other nations in the currency union.
However, we believe the continuing asset purchase programme in the US will most likely prove to be the most important element for markets in the year ahead. The Federal Reserve’s bond buying efforts have helped to push down bond yields, making equities a more desirable place for investors. The potential ramifications of a reduction in the programme were seen earlier this year when Fed chairman Ben Bernanke mooted a possible change in policy.
This was sufficient to cause equity markets to give back many of the gains seen in the early part of the year. The December meeting of the Fed saw the first announcement of an actual reduction in asset purchases, but this will not take place until January 2014. Changes to the bank’s forward guidance, which indicated that rates were likely to remain low for a more extended period, meant that the immediate reaction in equity markets was broadly positive.
For the year ahead, it does seem to us that earnings expectations remain ahead of reality, and that a noticeable improvement in economic growth and corporate earnings is required if equities are not to suffer a more volatile year. German companies are still outperforming their peers in the eurozone, and we believe that economic data continue to signal an improvement in business confidence.
Overall, our outlook for 2014 remains cautious, given the fact that expectations may have to adjust to an environment of lower earnings from companies, in the absence of any significant pick-up in economic growth. There are, however, signs that the worst of the eurozone crisis is behind us, which provides grounds for optimism that growth in other parts of Europe may be stronger. We will continue to look out for those companies that could benefit from this environment, while remaining vigilant for any changes in policy by central banks.
Rob Smith is fund manager of the Baring German Growth Trust
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