JULI 2, 21 ECONOMIC SITUATION AND STRATEGY Germany s economy: Europe s golden boy? Good economic data have come quite often from Germany in recent weeks. The country s most important leading indicator, the Ifo business climate index, has risen once more surprisingly for many because business conditions have improved again relatively significantly. The German economy, as read by the Ifo index, is thus already in a boom phase. 12 11 1 9 8 7 6 5 Global Trade Statistics (April 28 = 1) Ifo index for manufacturing industry since 1999 4 35 25 Recovery February 21 June 21 Boom Jan 3 Jan 5 Jan 6 Jan 7 Jan 9 Jan 11 business expectations 15 May 2 5-5 January 1999-15 Januar 21-25 June 28 October 21-35 -45 Dow nturn Recession -55-6 -4-2 2 4 current business situation World Trade Volume Singapore container vessel arrival Business is going well for many German companies now mainly because foreign trade has picked up considerably. Aggregate world trade has recovered significantly from its lows during the financial crisis and will probably reach the old highs of 28 again already this year. Even though the high growth rates of world trade cannot continue in the coming months, we expect that aggregate world trade will increase further. Economic momentum in Germany is currently surpassing not only the expectations of many investors, but also appears to be more pronounced than in many other European countries. That is reflected, for example, in the business confidence surveys that are comparable among the individual countries within the European Union. It is notable that business sentiment in Germany fell exceptionally far during the crisis, while the loss of confidence was not as severe in Europe overall. However, German businesses on balance are now more optimistic about the future, while European industry is still skeptical and has even lost some confidence recently. 4 3 2 1-1 -2-3 -4-5 Jan 92 Germany: New orders from abroad and exports Jan Jan 6 3 2 1-1 -2-3 -4 2 1-1 -2-3 -4 Jan 7 Apr 7 Industrial sentiment: Germany and Europe in comparison Jul 7 Okt 7 Apr 8 Jul 8 Okt 8 Jan 9 Apr 9 In our view, the German economy s strong position within Europe is not due solely to cyclical development, but also to structural factors. Jul 9 Okt 9 Apr 1 New orders from abroad (y/y) Exports (y/y) Ifo export expectations (r.h.s) After a rapid race to catch up in exports, German businesses are therefore likely to continue profiting from business abroad in the coming months. That may already be seen in new orders, which have increased by more than 3 on last year. The momentum of foreign orders and exports cannot be maintained for the rest of the year, in our opinion, but considering the global recovery of trade, we do not expect burdens for German companies to arise from foreign business in the relatively near term. Other European countries, e.g., the Netherlands, have likewise managed to benefit from the recovery of world trade. Compared with the EU average, however, Germany s ratio of exports to GDP is high, so other EU countries on average will not be able to participate as strongly in the advance of world trade. The export ratios presented in the chart would even be lower for the EU and the euro area if the German economy were left out of account. 1
45 44 43 42 41 4 39 38 37 Export ratio (Exports to GDP in percentage points): Germany and Europe in comparison But the gratifying economic trend in Germany is not solely attributable to foreign trade. Domestic demand, particularly from businesses, has also increased. 9 88 86 84 82 8 78 76 74 72 7 Q1 1993 Q1 1995 Germany: Capacity utilization and capital spending Q1 1997 Q1 1999 Q1 21 Capacity Utilization Q1 23 Q1 25 Q1 27 Captial Spending (y/y; r.h.s.) Q1 29 Q1 211 2 15% 1 5% -5% -1-15% -2-25% Equipment spending has thus stabilized recently, and with capacity utilization rising, capital spending propensity is likely to increase in the coming months. This assessment accords with the recent statements of large German companies. And Germany is also ahead in a European comparison with respect to average capacity utilization (EU16: 75.5%), so demand for capital goods is likely to increase faster there than in neighboring European countries. 55 5 45 4 35 3 Germany: Unemployment figures and number of short-time workers Jan Jan 6 18 16 14 12 1 8 6 4 2 Moreover, the German economy is in comparatively solid shape structurally. That is shown, for example, by the positive developments on the labor market. The adjusted unemployment rate reported by the Federal Employment Agency is 7.7%, and the number of unemployed persons has been declining steadily for months. It is gratifying to note that short-time work, an instrument created by the government to bolster the labor market, is evidently working. Since the beginning of the year, the number of shorttime workers has decreased further, without unemployment rising as feared; companies have largely transferred the employees to full-time status. Perhaps short-time work has also succeeded because German businesses feared suffering a lack of skilled workers in a few years due to the demographic trend and are therefore now avoiding layoffs. Overall, however, we would also attribute the healthy state of the German labor market to other, structural factors. For, it is notable that the number of unemployed has been declining already since 25. It fell from a peak of 5 million at that time to below 3.2 million at the height of the financial crisis. In addition to the labor market reform (Hartz IV) under Chancellor Gerhard Schröder, the fact that wage agreements between unions and employer associations have been moderate in the past years has also contributed to that. 3% 1% -1% - -3% - Jan 92 Jan 93 Jan 95 Germany: Productivity and unit labor costs Jan 97 Jan 99 Jan Productivity (y/y) Jan 1 Jan 3 Jan 5 Jan 6 Jan 7 Unit labor costs (r.h.s.) In EU comparison, Germany is also a forerunner in this respect. For, the productivity trend in Europe shows that the German economy has gained in competitiveness relative to its neighbors through wage restraint. Because of the productivity decline due to short-time work, unit labor costs for the overall economy in Germany have increased by 4. since 25, but unit labor costs in the euro area have risen in the same period by almost 1 on average. It is therefore no surprise that unemployment rates are substantially higher in Europe and the euro area than in Germany. In the chart, the unemployment rate is presented in accordance with the OECD s standardized data collection method, so the rates are comparable with one another. Jan 9 Jan 11 1 8% 6% - - Short-time w orkers and unemployed persons Unemployment figures Number of short-time w orkers (r.h.s.) 2
12 Unemployment rate (percentage points): Germany and Europe in comparison for a relatively long time. The more dynamic economic development compared with most European neighbors will therefore continue, in our opinion. 11 1 9 8 7 6 Jan-5 May-5 Sep-5 Jan-6 May-6 Sep-6 Jan-7 May-7 Sep-7 Jan-8 May-8 Sep-8 Another of Germany s structural advantages is that the national debt situation still looks comparatively bearable in comparison with other European countries. Germany has also been living beyond its means for years and has piled up a huge mountain of debt. However, particularly in comparison with Southern European countries, this has so far not caused investors to withdraw their confidence in the country. Instead, in respect to financing, Germany has even managed to benefit from the European national debt crisis. German federal bonds (Bundesanleihen) have been sought as a safe haven and have therefore been yielding lower. The German government consequently has the advantage of having comparatively broad room for economic policy so overdue austerity measures can be carried out while impeding growth as little as possible. Government debt in selected countries (in % of GDP) Year 198 28 29 21 Jan-9 May-9 Sep-9 Jan-1 May-1 18 17 16 15 14 13 12 11 1 9 8 Mar-9 Apr-9 Stock market: Germany and Europe in comparison (March 29 = 1) May-9 Jun-9 Jul-9 Aug-9 Sep-9 Oct-9 Nov-9 Dec-9 Jan-1 Feb-1 Mar-1 DAX EUROSTOXX 5 STOXX 5 That this finds expression in better relative performance of German stocks compared with other European stocks has also already become apparent in recent months. It has also contributed to the weak performance of European stocks that Southern European financials have burdened the STOXX indexes. But in our opinion, the relative performance also reflects the fact that economic development is stronger in Germany than in large parts of the euro area and the European Union. Other European markets like Spain are now more attractive from a valuation perspective, but German stocks continue to be cheap in absolute terms. Since we believe that economic development will continue to be better in Germany than in the rest of Europe, we recommend keeping German stocks slightly overweighted compared with European stocks in the future. Apr-1 May-1 Jun-1 Germany 3,3 73,1 76,7 79,7 Eurozone 33,4 78,2 84 88,2 EU 73 79,3 83,7 UK 52,7 68,6 8,3 88,2 United States 43,9 65,2 75,5 87,8 Source: German Ministry of Finance; as of November 29 The German economy is likely to continue benefiting from the above-mentioned positive cyclical and structural factors 3
Weekly outlook for the period of July 5-9, 21 Feb. Mar. Apr. May June July Release DE: PMI, services 52.2 51.9 55.2 54.8 54.6 July 5 DE: New orders, m/m. 5. 2.8% 1.5% July 7 DE: New orders, y/y 24.6% 26. 29.8% 26. July 7 DE: Trade balance, sa. 12.1 13. 12.8 13.1 July 8 DE: Industrial production, m/m -.2 % 4..9%.7% July 8 DE: Industrial production, y/y 5. 8.6% 13. 9. July 8 DE: Consumer prices, m/m..5% -.1%.1%.1% July 9 DE: Consumer prices, y/y.6% 1.1% 1. 1..9% July 9 EU16: PMI, services 52.5 51.8 55.6 56.2 55.4 July 5 EU16: Retail sales, m/m -.1%.7% -1.5%. July 5 EU16: Retail sales, y/y.1% 1. -1.5%.3% July 5 Q1 29 Q2 29 Q3 29 Q4 29 Q1 21 Q2 21 Release EU16: GDP, q/q -2.5% -.1%..1%, July 7 EU16: GDP, y/y -5. -4.9% -4.1% -2.1%,6% July 7 MMWB estimates in red. Chart of the week: US consumer confidence weaker than feared USA: Consumer confidence and consumption 16 1 14 8% 12 1 8 6 4 6% 2 - - May-68 May-71 May-74 May-77 May-8 May-83 May-86 May-89 May-92 May-95 May-98 May-1 May-4 May-7 May-1 Consumption (y/y; r.h.s.) Consumer Confidence (Conference Board) The decline of US consumer confidence on the preceding month based on surveys conducted by the Conference Board, a private economic research institute, is a shot across the bow for the markets, which is reflected in falling stock prices. In the historical context, the decline by 1 index points is not especially striking and in itself would be no reason for alarm. However, both expectations and ratings of current conditions have worsened in the current survey, and that at an already very low level. While many real economic indicators, such as industrial production, new orders, and trade volume, are striving back in the direction of their old highs, consumer confidence in the United States is dipping significantly below what one would expect in view of other economic data. That is largely due to development of the labor market, which has now stabilized at a very low level but is still sending no clear signal of impending recovery. The labor market is a trailing indicator and should therefore not be used to make economic forecasts, but a weak labor market combined with disappointing consumer confidence certainly does not have a positive effect on growth expectations for the coming quarters, since a large part of GDP growth in the United States is still determined by consumption, especially as US exports are likely to suffer from a stronger US dollar. Nevertheless, there is no reason to spread only gloom. Even the currently low consumer confidence would still be compatible with positive growth of US consumption. That is true especially when one uses the more meaningful and less volatile 3-month average for consumer confidence. 4 M.M.WARBURG INVESTMENT RESEARCH
As of Change versus 1.7.1 25.6.1 1.6.1 1.4.1 31.12.9 Stock markets -1 week -1 month -3 months YTD Dow Jones 9.733-4,1% -2,9% -1,9% -6,7% S&P 5 1.27-4,6% -4, -12,8% -7,9% Nasdaq 2.11-5,5% -5, -12,5% -7, Wilshire 5 1.712-4,8% -4, -12,6% -6,8% DAX 5.857-3,5% -2,1% -6,1% -1,7% MDAX 7.811-4,3% -2, -6, 4, TecDAX 72-4, -3,3% -12,8% -11,9% EuroStoxx 5 2.519-4, -3, -15, -15,1% Stoxx 5 2.35-3,9% -3,7% -13,6% -1,9% Nikkei 225 9.192-5,6% -5, -18,3% -12,8% Topix 828-4,5% -5,9% -15,9% -8,7% Bond markets 3 months Euribor,78 3 8 15 8 3 months Treasury Bill,17 4 1 1 11 1 year US Treasuries 2,95-17 -32-93 -89 1 year Bunds 2,57-4 -1-52 -81 1 year JGB 1,7-8 -18-29 -21 US mortgage rate 4,69-9 -3-36 IBOXX AAA, 3,11-2 -1-19 -53 IBOXX BBB, 4,84 5 4 37-27 ML US High Yield 9,21 18-13 6 1 JPM EMBI+, Index 517,1% 2, 1, 4,9% Convertible Bonds, Exane 25 4.67-1,1%,6% -6, -3,8% Commodities CRB Index 469,88-1,6% 2,6% -,6% -3, MG Base Metal Index 38,5-3,1% -4, -2, -14,7% Crude oil Brent 75,52 -,9% 1,1% -8, -3, Gold 1217,8-2,9% -,7% 8, 11,1% Freight rates Baltic Dry Index 2.351-6, -42,3% -21, -21,8% Currencies Financial markets at a glance EUR/ USD 1,2328,3% 1, -8,5% -14, EUR/ GBP,8241, -1, -7, -7, EUR/ JPY 18,14-1,7% -2,3% -14, -18,8% EUR/ CHF 1,3178-2,6% -7,1% -7,1% -11, USD/JPY 87,63-1,8% -3,7% -6,6% -5,7% Carsten Klude Dr. Christian Jasperneite Matthias Thiel +49 4 3282-2572 +49 4 3282-2439 +49 4 3282-241 cklude@mmwarburg.com cjasperneite@mmwarburg.com mthiel@mmwarburg.com The reports, tables, and charts presented are based on reliable information from publicly accessible sources. We, however, make no guarantee of accuracy. The content is protected by copyright. M.M.WARBURG INVESTMENT RESEARCH 5