Since 1973 there have been five economic recessions in Germany: 1974/75, 1981/82, 1992/93, 2002/03 and 2008/09. We have analysed the extent to which corporate profits of DAX companies fell during these recessionary phases and share prices came under pressure. This makes it possible to approximately conclude the extent to which a recession on the stock market has been priced in today following a DAX price loss of 25% at its peak between January and December 2018.
Approximately, because the structure of the German economy has continuously changed since the 1970s. The composition of the DAX has also constantly changed. Today, the export business of DAX companies is far more important than it was decades ago. Nearly 70% of revenues of the 30 largest German companies are generated in the export business – far more than ten or 20 years ago. At the same time, significantly more is being imported, i.e. the degree of openness of DAX companies has increased, with the economic development in Germany alone thus playing a subordinate role. All in all, German companies have tended to become more susceptible to global economic fluctuations as a result of their greater openness. On the other hand, business processes within companies have become far more optimized today than they used to be, making it possible to more effectively control fluctuations in supply and demand.
Other critical points regarding this simple analytical approach are the focus on individual extreme prices (e.g. the DAX low on 12 March 2009), the fact that no account is taken of the interest return on alternative investments, failure to consider political and other external events at the relevant time (e.g. the attack of 11 September 2001), the initial situation of stock markets in terms of valuation (e.g. the overvaluation following the dotcom bubble) and market sentiment as well as the considerably higher liquidity in trading, also in the computerised area. Ultimately this means that only an approximation is possible.
What do the results show?
During the past five recessions, share prices on the DAX fell from their local high before the actual recession to their lowest level by an average of 40%. Corporate profits fell during this period by an average of 35%. Compared with the current situation (DAX high at 13,572 points in January 2018), a recession would be priced in at around 8,100 points and DAX corporate profits could drop to 680 index units (currently 1,050).
Do these figures make sense?
To check their plausibility, a look at the price to book value ratio (PBV) proves useful. During the last recessions, stock market sentiment was so bad at its low point that the DAX was trading at a discount on the shareholders’ equity and the PBV was trading at less than 1. In other words: a company’s asset value was considered to be more valuable than the value of the future free cash inflows. This is an altogether plausible assessment given that the world is facing a major crisis, at least in economic terms, comparable with the financial crisis of 2008/09, for instance. Today, the book value of the DAX based on Bloomberg estimates lies at 7,800 points, i.e. not all that far from the calculated results, based on historical price and earnings time series.
The conclusion that can be drawn is that a recession would be priced into the DAX approximately in a range of between 7,800 and 8,100 points. From today’s level, the DAX would therefore fall again significantly if a recession were to occur. However, we still do not expect such a scenario to come about.