Summary
The Dax declined by 39% in 2008, 18% of which was in Q4 when the financial turmoil
escalated and the world was heading into the recession. We estimate German GDP has
fallen by 1.5% in Q4 qoq; German sentiment indicators IFO and ZEW reached record lows
(see right chart below). The first company announcements indicate a very weak Q4 reporting
season.
Our economists expect the most serious recession on record in Germany for 2009, with
GDP declining by 2.5% and a subsequent small recovery of 1.1% in 2010. We believe the
deep economic crisis will be caused mainly by the pronounced weakness in foreign demand,
which will likely result in a slide in 2009E exports by 6.3% yoy. In turn, weak export growth
should dampen capital spending; machinery and equipment spending could drop by more
than 10% yoy in 2009. Germany is still the biggest exporter globally; it previously benefited
from strong global growth and will now suffer from the strong, global, synchronous
slowdown in all regions. Exports of goods generated 45% of Germany's GDP in 2007, which
makes Germany much more dependent on exports than other countries.
In addition, German exports are strongly dependent on cyclical goods and the discretionary
spending of companies (capital goods) and consumers (cars). In 2009 we think companies
and consumers globally will seek to cut costs by reducing discretionary spending.
Accordingly, order intake of the German capital goods industry has declined by 32% yoy in
Nov.
Global Auto sales (light vehicles) in 2008E have fallen by 3.4 million units to 61.7 million units
and will most likely fall even steeper in 2009. Auto factories will most likely see massive
production cuts in 2009. Significant short-time work has already been announced by Daimler,
BMW, Volkswagen, MAN, Bosch and many more suppliers. The German car industry
employs 760,000 people directly and more than 5.3 million jobs – every seventh job in
Germany – depend indirectly on the automotive sector. In addition, unemployment, which
reached the lowest level since 2001 in 2008, is likely to rise significantly in 2009.
On the positive side, a stronger USD could support the German exports and our FX
strategists expect the EUR/USD rate at 1.20 in 12 months. Lower commodity prices could
also be supportive for the industry and private consumption.
The weak economic news flow is reflected in record downgrade momentum for earnings:
Dax consensus earnings for 2009 have been downgraded by 21.6% over the last three
months. The weak Q4 reporting is likely to trigger more strong downgrades over the coming
months.

The Dax consensus earnings growth in 2008E has already declined to -27.8% and could fall
to -40% over the next three months. The consensus bottom-up expectation for 2009E is a
small recovery with earnings growth of 11.0%. But from a top-down perspective, 2009
earnings are likely to fall well below the 2008 level. Sectors with the strongest downgrade
momentum are Autos, Banks, Industrials, Media, Technology and Transportation & Logistics.
These are also the sectors with the highest earnings uncertainty (see page 25). The current
Dax consensus P/E 2009E of 8.4x looks cheap at first glance, but is not really meaningful in
light of the ongoing strong downgrades (see page 24).
Reasons for ongoing earnings downgrades in 2009 include: 1) low sales growth or declining
sales, 2) significant margin reductions, 3) higher costs for interest-bearing debt, and 4) the
risk of goodwill write-downs. A few more details on these four risks:
1) DB analysts currently expect 2009E sales growth of 0.2%. This is already clearly
below the consensus estimate of 4.5%, but also still strongly ahead of the sales
decline of 3.3% observed in 2002/2003 (see left chart below).
2) Our analysts expect the 2009E EBIT margin for the German universe to fall to 8.1%.
This is clearly below the consensus expectation of 9.6%, but still way above the
margin level in 2001/2002 of 2.3%. If the margins fall to trough levels, then the DB
P/E for 2009E would increase from 11.8x to 33.9x (see right chart below).
3) Higher re-financing costs may also come into the focus, especially for companies
with low credit ratings or no access to the bond market. Government bond yields
have strongly declined and the corporate risk spreads have strongly increased.
Therefore, companies with strong credit ratings may see a small net benefit,
whereas companies with a low credit rating may see a negative net impact. In
recent weeks, the issued corporate bond volume has increased which offers some
hope. However, only around 40 German large companies have a bond rating and
access to the bond market. The smaller companies are much more dependent upon
other financing sources. The cost gap between financing via bonds and via other
loans was relatively small in the past, but seems to be much wider now. This could
be a clear disadvantage for mid and small cap companies in 2009 and a reason for
some investors to avoid these size classes. We analysed this theme in detail for the
Dax and MDax companies (see from page 6 onwards). In addition to the bond
issuance, many cyclical companies may consider capital increases in 2009 in order
to strengthen the equity base.
4) Many German companies have done major acquisitions in the last few years at
higher price levels than the current market levels. Companies may have to writedown
the goodwill for their 2008 annual reports, a theme which has come into
special focus after the substantial write-down of the Royal Bank of Scotland. Dax
companies with significant write-down risk include Allianz, Bayer and SAP.

Due to the recession, governments around the world have approved sizeable stimulus
packages. The German government approved a second stimulus package of EUR50bn in Jan.
Together with the first package, the fiscal stimulus for this year and the next is likely to reach
EUR62bn (2.6% of GDP in total or 1.3% per year). The second package contains tax
reductions, a one-off child bonus, a EUR2500 incentive for new car purchases, an increase in
infrastructure expenditures and others (see details on page 22). German exporting
companies may also benefit from the other stimulus packages around the world. The US
package of USD825billion planned by the new Obama administration and the considerable
Chinese package could be especially relevant.
For the German banking sector, the German Financial Market Stabilization Act (SoFFin) was
approved in Oct 2008 and includes EUR80bn for direct Bank aid and EUR400bn for capital
guarantees. HSH Nordbank, IKB, Hypo Real Estate, BayernLB and VW bank applied for state
guarantees. Commerzbank has requested EUR18bn in direct aid and the German state
acquired a 25% stake in Commerzbank plus one share.
In addition, the federal election in Germany in Sept 2009 could become interesting for the
equity markets in the coming months. The election could end the current grand coalition
between Conservatives and Social Democrats. A coalition between Conservatives and
Liberals (the outcome of the latest state election in Hesse) would be the best option for the
equity market, but the current polls are tight.
The Q4 reporting season, which will start soon, could bring significant dividend cuts.
Currently, consensus data expect dividend reductions for only 11 of the Dax companies, but
we think disappointments are likely. Furthermore, top line results should come in much lower
than expected and the companies’ outlooks should be very cautious. For the Dax, we expect
ongoing high volatility over the next three months and see a significant risk of the Dax falling
to 3500 or below during the weak reporting season and ongoing strong downgrades. In the
course of Q2 2009, the market could start to stabilise. This stabilisation should probably be
driven by an improvement in the macroeconomic environment. This might be triggered by
the economic stimulus programs.