MDAX valued ever higher, but no sign of a trend reversal

Small and mid-caps are popular. The MDAX, which is made up of the shares of 50 medium-sized German companies, has clearly left the DAX standing since the beginning of the year. To date the smaller index has increased its value by more than one fifth. The DAX bellwether index itself is near its all-time high and has managed to catch up to some extent, but this year too it has lost ground against the MDAX with a performance of 17%.

In a long-term comparison the MDAX is the star among the indices of the DAX family. Since 1988 the mid cap index has gained 11.7% a year, while the DAX has managed “only” 9.1% a year. The difference of 2.6% a year means the MDAX is now roughly twice as high as the DAX because of the compounding effect.

The small & mid cap indices are home to a mixture of companies from very different sectors. These stocks are heavily tilted towards the mid cap segment and are focused on niche markets in which growth has been higher than at the DAX groups in the past few years. Experience teaches that these mid cap companies also suffer less from negative global political events (e.g. Brexit, North Korea conflict) than the big DAX companies, which operate in all key markets of the world and are thus unable to avoid crises.

What’s more, the DAX is naturally made up of the sector bellwethers of German industry, companies that have grown strongly in the past and were, therefore, listed in the index of the biggest German companies. These stocks stand for the key industries that have characterised the German economy during the past 60 years. They include automobile, chemicals and industrial stocks. While these are also still growing today, they have their strongest growth period behind them.

After the good run that they have had, it is worth taking a look at the mid-caps’ current valuation. In all categories we have looked at the MDAX has become significantly dearer. This is revealed by a comparison with the historical averages, which among other things show a 20% overvaluation for the PER. A similarly high mark-up was last to be seen in 2014.

 

Is the big bang now looming?

The rally staged by MDAX and SDAX is an indicator for the fact that the equity markets are in a very late phase of the upturn. Such a late phase is characterised by – among other things – the fact that small caps are no longer small and mid-caps are no longer medium-sized. On average today an SDAX company weighs in with a market capitalisation of EUR 930 million, a MDAX company with EUR 4.6 billion. It is no longer possible to talk about “second-line stocks.”

The tendency towards valuation levels that are permanently above the historical average in combination with the low level of volatility in the equity market is a strong warning signal that the upswing cannot continue at this pace. A similar situation was already seen in 2014 when the MDAX showed signs of weakness over a longer period. So the time would seem to be ripe for a correction. On the other hand, the world economy is going excellently, corporate profits are also increasing strongly at the MDAX companies. The central banks are keeping interest rates low and are flooding the markets with money, and there are hardly any attractive alternatives to shares. These conditions are showing no sign of embarking on a trend reversal. But sharp share price corrections are possible at any time for individual stocks.

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