As the euro-region economy struggled to emerge from recession in recent years, officials could at least comfort themselves with the performance of the German economy: "We'll always have Frankfurt," to miscoin a phrase. That's no longer true.

German investor confidence has worsened for eight consecutive months; today, it collapsed to its lowest level in two years. The euro-region economy is in flames. Here ends the argument that the world of finance and economics is shrugging off Ukraine and Iraq and Ebola and Gaza and all the other geopolitical risks currently assailing the headlines.

A sentiment index measuring faith in the six-month economic outlook dropped to 8.6 this month, according to the ZEW Center for European Economic Research in Mannheim. The index has slumped from a seven-year high of 62 reached in December. ZEW explained the situation thus:

The decline in economic sentiment is likely connected to the ongoing geopolitical tensions that have affected the German economy. Since the economy in the euro zone is not gaining momentum either, the signs are that economic growth in Germany will be weaker in 2014 than expected.

Figures scheduled for release on Aug. 14 are likely to show that the German economy, Europe's biggest, contracted by 0.1 percent in the second quarter, according to the median forecast of economists surveyed by Bloomberg News. The euro zone as a whole will be lucky to manage growth of 0.1 percent, based on data scheduled for release that same day. So just one slip and the region will be flatlining; two slips, as it were, and recession will be just one quarter away:

David Fuller's view

We are back in a nervous market environment, as you will have noticed, not least in Europe.  Investors generally react in two different ways: 1) cut positions and head for hills; 2) start to get interested as valuations improve.

There is plenty to worry about, as the article above points out.  The four factors mentioned in the second paragraph above are certainly serious in addition to being newsworthy.  However, Ebola and Gaza have little to do with Germany’s stock market.  The same can be said for Iraq, provide the price of crude oil does not rise, and fortunately it has fallen recently.  The situation in Ukraine, which I would prefer to describe as Putin’s reckless and cynical aggression, is serious for Germany, not least in terms of sanctions.  However necessary, and I believe they are, sanctions are a medium-term lose-lose situation for the economies of countries involve. 

There is an old investment adage: If you are going to panic, panic early.  There were warnings for Europe from the deteriorating situation in Ukraine, and especially as sanctions were increased following the MH17 massacre.  Today, I think it is too late for serious medium or longer-term investors to panic out of German or most other European stock markets, especially if they hold quality issues with attractive dividends.  Sure, Germany is no more than oversold in the short term, and with no end to the sanctions currently in sight, European stock markets could easily slip lower as investors avoid them because of the current political and economic risks (see yesterday’s email).   

However, in respected developed economies where some world-class shares are listed, value investors understandably become interested when they are out of favour.  I am not saying that one should go rushing in this week, because sanctions are usually at minimum a lengthy medium-term process.  Moreover, they will hurt GDP growth and corporate profits, as we are already seeing and hearing.  So this is the time to do one’s homework and line up some companies that are already undervalued relative to the German DAX Index, p/e 16.64, yield 2.95%.  The further they fall, the more interesting they become as future recovery candidates.

Here are some of them: Allianz SE (ALV GY) est p/e 9.06, yield 4.26%, BMW (BMW GY) est p/e 9.70, yield 2.98%, BASF (BAS GY) est p/e 12.87, yield 3.63%, Deutsche Lufthansa (LHA GY) est p/e 10.78, yield 3.56%, Volkswagen (VOW GY) est p/e 8.33, yield 2.40%, E.ON (EOAN GY) est p/e 14.31, yield 4.55%, Muenchener Rueckver (MUV2) est p/e 8.36, yield 4.92%, Daimler (DAI GY) est p/e 9.77, yield 3.76% and Deutsche Boerse (DB1 GY) est p/e 14.55, yield 3.93%. 

There are plenty of other interesting companies in Germany but they are currently more expensive, although that may change.  Currently, Deutsche Lufthansa has been hardest hit because airlines will have to change their flying routes over Eastern Europe and that will hit costs.  However, this is a medium-term problem in what is an overall much more attractive environment for airlines, due to more efficient aircraft, increased traffic and better pricing power.  Germany’s world-class automobile manufacturers would also be very attractive prospects at somewhat lower prices. 

Lastly, Europe and even the USA’s involvement in sanctions and counter sanctions with Russia can only siphon some international investment capital away to inform and unaffected markets, including China / Hong Kong and India.  The former is just emerging from its long underperformance, while the latter is consolidating gains following its upward breakout.