What does record-high German business confidence mean for stocks?

by Emma Stevenson, Investment Writer at Schroders.

We look at what the Ifo index tells us about German business sentiment and the prospects for equities.

The German Ifo business climate index is at a new record high, surpassing the previous peak registered in 1969, the year of the moon landings. But what does this mean, and what does it imply for equity markets?

The index is a survey of business sentiment in Germany. The index compiler (the Ifo Institute for Economic Research) asks companies across the manufacturing, construction, wholesale and retail sectors to give an assessment of both the current business situation and their business expectations for the future.

Optimistic expectations

The chart below shows the Ifo index hit a new record high of 117.5 in November 2017. This indicates buoyant sentiment among German businesses.

That said, the breakdown of the index suggests that companies’ assessments of the current business situation are no longer as positive as in October. That reading slipped back to 124.4 in November from 124.8 in October.

However, business expectations were far more optimistic (111.0 versus 109.2), leading to the record high for the overall index.

In particular, the manufacturing sector reported very upbeat expectations. This is interesting as capital expenditure (capex) by companies has been fairly disappointing since the end of the global financial crisis. A potential pick-up in capex could help to extend the current period of global growth.

The data points to an ongoing positive outlook for the German economy and German companies, even after the recovery seen this year.

Limited impact from political uncertainty

It is notable that the slow progress on forming a government after Germany's September elections seems to have had little bearing on business sentiment.

However, the Ifo institute said that around 90% of responses were submitted before the collapse of the “Jamaica” coalition talks between Angela Merkel’s CDU/CSU, the Greens and the FDP.

The next Ifo index reading, due on 19 December, may shed further light on the impact that the political uncertainty has had on business sentiment.

Fund manager view: Martin Skanberg, European equities, says:

“Forward-looking economic indicators in Europe have been exceptionally strong and the Ifo is one example of this. The fact the expectations index is so high suggests the current economic expansion should continue.

“This implies an encouraging backdrop for companies operating in Europe. 2017 is on track to be the first year of corporate earnings growth for quite some time and valuations have moved up to reflect this. We see good prospects for 2018 too. There is scope for profit margins to improve as pricing power returns (i.e. companies are able to increase their prices without denting volumes).

“The outcome of the German election has produced some uncertainty. However, this can be over-played, and the evidence so far suggests it has not dampened the economic recovery. Should there be market volatility as a result of political uncertainty, we could see some mispriced opportunities emerge and we would try to take advantage of this.”

This article has first been published on schroders.com.