We upgrade because:
* The euro. Germany is the most sensitive market to the euro. We see short term euro consolidation because the euro is overbought, has significant net long positions and we believe there is a 90% likelihood of a December Fed rate hike (versus the market pricing 71%) which should help the dollar. Long-term we remain euro bulls.
* China. China-exposed plays (autos, capital goods and bulk chemicals), which Germany is overweight, closely follow China PMIs yet have underperformed.
* Economic outlook. Germany continues to outperform other economies in Europe (German PMI and IFO have not reacted to euro strength) and Germany is the most competitive European economy on the World Bank’s Ease of Doing Business index.
* Valuation. Germany is cheap on 12 month forward P/E (14% discount to continental Europe) and on CS HOLT®’s economic P/E (8.3% discount to continental Europe).
* There is life in German equities outside of autos and chemicals, the sectors which have been responsible for the majority of Germany's outperformance in the past two years.
* Politics. While the new government coalition is potentially going to be less stable than the previous one, we are likely to see easier fiscal policy and maybe more pro-business policies (particularly on labour regulation).
German residential real estate: we have been overweight German residential real estate for 5 years and would continue with this (Deutsche Wohnen and ADO are Outperform-rated by our analysts).
German stocks that appear cheap on CS HOLT with an Outperform rating and positive earnings revisions are: Evonik, Fresenius Medical Care, Kloeckner, Siltronic, Uniper.