Dr. P.V. Viswanath
The darkest hour before dawn
Deutschland AG is starting to look like a bargain
ALMOST everywhere, equities, property and bonds look expensive compared with what they used to fetch. Investors have pushed up prices to giddy heights in their search for higher returns. Are there any assets left that still look cheap? Yes, curiously: in Germany.
German shares are undervalued compared with those in America and the rest of Europe (see chart 1). Not only do they trade at lower multiples of earnings than elsewhere; their p/e ratios are also lower than they used to be in Germany itself.
Then there is property. Long the most expensive in Europe, German houses are also starting to look like a bargain. While house prices elsewhere have soared, in Germany they have been falling for most of the past decade. Figures from Barclays Capital, the investment-banking division of Barclays Bank, show that in 1985 the average house cost three times as much in Germany as in the rest of the euro area, while today they cost roughly the same. In relation to incomes, though, German homes are now cheaper than the European average (see chart 2).
Sceptics will argue that Germany's assets are cheap because its future growth prospects are poor. It has been the slowest-growing economy in the euro area for the past ten years, and its GDP figures for the second quarter (due on August 11th) are expected to disappoint again. But the tide may be turning. Corporate Germany is in the throes of a big shake-up among top managers. Even before this began, German firms had hugely improved their competitiveness and profits in recent years by slashing costs. Thanks to faster productivity growth than the euro-zone average, combined with the slowest wage growth, Germany's unit-labour costs have fallen by 10% relative to the euro-zone average over the past five years.
The threat that factories could be moved to central Europe has forced workers at many big German firms to work longer hours or take a pay cut. Government reforms to make labour markets more flexible have also gone further in Germany than in Italy or France. According to Morgan Stanley, an investment bank, more than 30% of Germany's workforce now have part-time or temporary jobs, allowing firms to make better use of workers.
Mainly as a result, companies are pricing themselves back into world markets, and profits have surged. Germany is the only G7 country to have increased its share of world exports over the past five years. The snag is that all this cost-cutting has depressed real domestic demand, which has more or less stagnated for five years. Fears about job security have hurt consumer confidence and spending. This, in turn, makes companies reluctant to expand.
Despite this gloom, analysts at ABN Amro, a Dutch bank, are tipping Germany to become one of the strongest performers in Europe. They point to some tentative signs that stronger profits are starting to make businessmen happier. The Ifo survey of business confidence rose by more than expected in July. And a likely change in government after the general election in September should accelerate reforms and give another fillip to business.
There are also signs that the labour market is stabilising, with unemployment in July falling for the fourth month running. Other indicators confirm that the worst may indeed be over. Job vacancies are 50% higher than a year ago, and the latest survey by Manpower, a recruitment agency, shows a sharp increase in firms' hiring intentions in the third quarter. This is the biggest improvement in the indicator for any large economy in the past year.
Even if Germany's unemployment rate (now 11.6%) remains high, so long as it continues to fall, concerns about losing jobs will ease and consumers may think about opening their wallets. The economists at ABN Amro suggest that the weakness of consumer spending in recent years implies a significant pent-up need to replace durable goods. German households still save 11% of their income, unlike their house-rich American counterparts who, according to the latest figures, now save exactly 0%. So there is scope for a modest fall in saving—hence a bigger rise in spending—once Germany's consumer angst fades.
Improved employment prospects are only one reason why the economy may be set to pick up. House prices too, have room to rise—unlike in most other countries. And if both consumer spending and property prices recover, they are likely to reinforce each other.
A new report by Merrill Lynch, an investment bank, reckons there is a good chance that German house prices could take off. The rate of home ownership in Germany, at 44%, is the lowest in the rich world. Much of the housing stock is owned by companies or by regional and central governments, many of which are now being forced to sell their portfolios in order to raise money.
In the short term, this additional supply could keep prices low. But if home ownership becomes more widespread, prices should rise eventually. So far, the properties are mainly being snapped up by foreign financial institutions, but this could be a half-way house to wider owner-occupancy and higher prices. Merrill Lynch says that private-equity firms and banks will want to realise the value of their portfolios. Some investors, such as Terra Firma, a British private-equity firm, have already linked up with mortgage providers to finance and sell properties to tenants.
Faster productivity growth, stronger consumer spending and rising asset prices? Germany's “new economy” may be waiting in the wings.