European equity markets have started the New Year in poor form, with further double-digit declines f...
European equity markets have started the New Year in poor form, with further double-digit declines following three calendar years of negative returns.
The reasons for this continued disappointing performance have been well documented, reflecting concerns about the global economic environment as well as continued geopolitical tensions.
We continue to expect high levels of volatility for the immediate future. Our strategy throughout 2002 and into 2003 has been to adopt a cautious outlook with regard to European economic growth.
While we remain concerned about the pace of economic recovery, it is noticeable our below-consensus views have become more consensual, with most economic observers downgrading their economic forecasts. However, given the improved valuations at the individual stock level, we are starting to identify pockets of value within the stock market.
The relative underperformance of European equity markets can be explained by the market perception fiscal and monetary response has been ineffectual. The ECB has been criticised for its continued focus on preventing inflation rather than stimulating growth.
While we expect a more accommodative attitude from the ECB as a result of reduced inflationary expectations, the divergent economic performance and outlook for member countries does limit the potential flexibility for interest rate reductions.
The fact that even with further rate cuts, the ECB will still be running a clearly inappropriate policy stance for the German economy has compounded the negative sentiment directed toward Europe's largest economy.
We share these concerns and the recent powerful surge in the euro, particularly in relation to the dollar, adds worries for the export-driven economies of northern Europe.
For example, German exports of goods and services to the US have grown from 2% of GDP in 1995 to almost 4.5% today, emphasising the increased exposure to currency movements.
Away from Germany, many of the issues facing Europe are cyclical and replicated in all equity markets. European equities are attractively valued relative to history and other equity markets and appear attractive compared to other asset classes unless we anticipate global economies moving into a double-dip recession.
In the short term, the tensions in the Middle East will ensure capital preservation rather than valuation remains investors' primary consideration.
While the economic recovery in Europe will stay muted, we are starting to see pockets of value in the market that are creating exceptional investment opportunities. Many companies are adapting well to greater capital discipline and should experience a rapid earnings recovery and re-rating as the investment environment improves.
However, we are continuing to aggressively underweight those areas within Europe where we see no pricing power and where the problems are more structural in nature.
Market attractively valued.
More accommodative attitude from the ECB.
Mid-Cap arena contains exceptional companies.
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