DAX earnings season - what to focus on?

• European markets are shut for Easter break

• High concentration of earnings in DAX index

• Around half of German blue chips can be labelled cyclicals

• Q1 2020 earnings season starts on April 21

• Coronavirus sell-off halted at 2000 and 2007 peak

Stock markets in Europe are shut for Easter holiday already. Such a day can be an opportunity to take a more fundamental-based look at the German index, DAX (DE30). Of course, we are in the midst of a coronavirus crisis and everything is uncertain, especially the future. In this short analysis we will take a look at DAX from the perspective of earnings concentration in the previous year and try to determine which earnings reports may be the most significant. 

DAX earnings did not recover from 2007-2009 decline until Q3 2011. It took DAX 5.5 years to retest pre-crisis price levels. Source: Bloomberg, XTB Research

Equity indices swing on hopes, fears, headline news or anything else that investors consider relevant in a crisis era. However, long-term valuations are ultimately driven primarily by earnings and expectations of these earnings. We are in a very uncertain time for the economy but what seems certain is that all the lockdown measures will cause earnings to drop. On the chart above we have compared DAX performance to changes in 12-month trailing earnings from continuing operations. Earnings dropped by a massive 83% between Q4 2007 and Q3 2009. Moreover, earnings did not recover above pre-crisis levels until Q3 2011! It took even longer for the DAX index to return to its pre-crisis peak - 5.5 years!

However, the coronavirus crisis is way different than the global financial crisis. Entire economies are getting locked down and the scale of lay-offs in the United States is unprecedented. It would be foolish to assume that the situation in Europe is looking better given that restrictions are much stricter on the Old Continent. Apart from that, one should also keep in mind the long-term impact of the Covid-19 outbreak on how people will behave. One can imagine that even if we managed to stop the virus, social distancing is here to stay for some time, be it forced or voluntarily. Restaurants, travel companies and most of the entertainment sector will suffer and it will provide a drag on economic activity. Not to mention damage done to cyclical companies by the economic slowdown itself.

Allianz, Volkswagen, Linde, Munich Re and Siemens can be seen as earnings drivers for DAX. Unfortunately, most of them are cyclicals. Source: Bloomberg, XTB Research

When it comes to the DAX index, there aren't many entertainment or travel companies in the index. However, there are quite a lot of cyclicals. The contribution of some companies to index' EPS was way out of proportion with their weights in the index in the previous years. Looking at data for 2019, one can see that 5 companies (Allianz, Volkswagen, Linde, Munich Re and Siemens) accounted for 60% of DAX weighted EPS. These 5 companies have a combined weight of 33.45%. What may be even more worrying than high concentration of earnings is where these earnings are concentrated. Allianz is an insurer and Munich Re is a reinsurer. Both companies are seen having a tough 2020 due to higher number of claims and poor performance of investment portfolios. Volkswagen (automotive), Linde (chemicals) and Siemens (industrials) are all highly cyclical companies. Summing up, rising claims and broad decline in economic activity is likely to be a massive hit to DAX' recent earnings drivers.

Earnings season in Germany starts later than in the United States with the first DAX member reporting on Tuesday, April 21. 22 out of 30 DAX members will report during the next 4 weeks, including 3 "earnings drivers" (highlighted in red). Source: Bloomberg, XTB Research

When we look beyond those 5 companies, we can see that more or less half of DAX members can be labelled cyclicals. Those companies combined with two insurers (Allianz and Munich Re) account for around 55% of index' weight and more than 80% of index' earnings! The German index is heavily biased towards cyclicals and it can lead to relative underperformance should slowdown last longer. For example, Dow Jones also has 30 members but banks and tech stocks account for around 30% of index' weight and almost 50% of earnings. On the other hand, DAX has a comfort of not having a single oil company among its members.

Taking a look at recent price action of DE30 on a monthly time frame, one can see that the index has been reacting to key technical levels. The 8,000 pts mark served as final support in March while 38.2% Fibo retracement of upward move started in 2003 (9,400 pts area) halted declines in April so far. Note that the aforementioned 8,000 mark was more or less the peak of the dot-com bubble as well as the rally preceding the global financial crisis. This level will be on watch in case the second big wave of selling starts. So far, this year's market sell-off (-42% from top to bottom) has been smaller in percentage terms than drops that occured during dot-com bubbles burst (-73%) or global financial crisis (-56%). However, it was also way shorter as it lasted just 2 months (so far) compared to 36 months during dot-com and 15 months during the global financial crisis.

Source: xStation5