Volkswagen & DAX: Allocation & Dislocation

As the Volkswagen fallout intensifies and shares plummet 41% so far this year, the high concentration of auto-industry stocks Germany's DAX is worth watching.  Germany's automaking sector makes up 16% of the 30-stock DAX index, compared to only 5% for the Eurostoxx. In the US, autos and autoparts shares make up 1.1% of the S&P500, 0.3% in the FTSE-100, 9% in the Nikkei-225, 12% in the Topix and 3% in the Shanghai Composite.

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The surging positive correlation between VW and the Dax stood as high 79% as early as two months ago before tumbling in the midst of VW price collapse. The high concentration of auto-related stocks in the Dax implies that suppliers, auto-parts makers and even competitors (BMW and Daimler) will continue to drag on the index.

It is not far-fetched for mean-reversion to ensue in the VW-DAX correlation. The transmission mechanism for DAX to catch-down with VW is explained in more detail below and the quarterly cycle patterns are covered in our DAX Premium trades.

Qatar Holdings is revealed to have lost about $4.8 bn from its VW common shares as a result of its 17% share of VW common stock and 13% of its preferred stock.  When will sovereign wealth funds losses prompt broad selling in VW shares remains to be seen.

The cascading of VW ratings downgrades from a wide array of banks and brokerages (SocGen, Deutsche Bank, Natixis, JP Morgan, DZ Bank, Equinet, Magna, Safra and Kepler Chevreux) to a sell or a hold is far from complete. So far, nine brokerages/banks have downgraded the stock, most likely prompting further allocation shift and downgrades from asset and fund managers.