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Germany: Good medium term outlook

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When assessing the medium term for the German market, analysts are distinctly bullish despite short term concerns about interest rates due to the deutsch-mark's notable depreciation against the dollar.

Gernot Nerb, chief economist at Salomon Brothers in Frankfurt says they expect GDP growth of 2.5% this year underpinned by a bouyant export performance in contrast to moderate domestic demand.

The CPI is edging up. The latest preliminary figure for July is 1.8%. By year-end we could reach 2% with some influx from imported prices," he says, adding that this is close to the acceptable Bundesbank margin.

However, he says that the the relation between import prices and CPI is relatively loose, making only 15% of the index while it remains difficult to pass on higher prices.

"The Bundesbank has al-ways said that the domestic price performance is the crucial thing, so M3 is on target with the CPI edging upwards but still under control.

"From a purely domestic point of view there wouldn't be a reason to hike rates." With the deutschemark still weakening, however, the Bundesbank could move within the next two or three months to put up the variable rate bringing the first rise in the cold rate since 1992. Sal-omon Brothers predicts a rise from the current 3.3-3.4 to 4.0 by year end with a ten year bond rate of 6%. "It is a moderate upward trend. We have clearly seen the bottom of in-terest rates," he concludes.

This predicted rise will have an impact on the equity market. Hans Jurgen Segbers, head of equity strategy with the investment group of Dresdner Bank expects some market correction possibly back to 4100 in the short term. Me-dium term, he thinks that the fundamentals are good, with low interest rates, increasing profitability in the industrial sector and restructuring in the financial sector.

Karl Debenham, German equity analyst with Merrill Lynch in London describes the medium term outlook as "extremely good with the best opportunities outside the DAX30".

The low interest rate environment is the most important driver for Segbers. "This corresponds with pressure on all institutional investors: pension funds, insurance companies and mutual funds to be creative and to use riskier assets to get the performance they need." He adds that markets have also been helped by the consideration of pensions reform.

There has also been a change in the behaviour of private investors who have been putting more money into equities although 80% of their investments are in life insurance or in bonds and he admits that a correction of more than 10% would see them pull out. However he adds: "There is a lot of underlying demand for equities which we see in our mutual fund business with an in-crease in capital going to European and German eq-uity funds."

Debenham says that that there have been two key factors behind the market's recent momentum. "One is increased inward investment mainly from the US and two is the perception of advantage given to the main DAX stocks by the weakening of the deutchemark against the dollar with its significant translational impact."

Risk premiums have fallen and the yield on gilts has not gone up while valuations in terms of cash flow multiples do not look "particularly strained," says Debenham

"Germany has historically enjoyed a higher price-to-earnings ratio than many other markets because of the preponderance of cyclical industrial stocks within its index," he adds.

Both Segbers and Debenham identify the interest rate situation as a major risk. Segbers explains: "The main risk is the dynamic and speed of increase in the dollar. There is still a price for the dollar - that nobody knows - where the German Fed has to raise in-terest rates." Debenham says the risk is an increase in me-dium term interest rates and "the collapse of the reform process, of economic, regulatory and fiscal liberalisation".

In terms of sectors, Segbers believes as with other commentators that financials will continue to outperform the DAX in the next six months. He also favours Germany's three chemical giants which have recently been underperforming the DAX, particularly the DAX 30.

Examining the noticeable laggards Debenham says that in construction interim figures for two large companies have been surprisely good, so there is hope for a pick up.

Retail, a "defensive laggard", is not affected by the political and interest rate risks but by increased purchasing power absent because of the depressed domestic market. "It is possible that if the deutschemark strengthens and the process of reform stalls, interest could focus on the domestic oriented sector."

John Lappin "

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