By Richard Pease, a fund manager at New Star Asset Management The third quarter of this year pro...
By Richard Pease, a fund manager at New Star Asset Management
The third quarter of this year proved a torrid time for European equity markets. Germany's Dax and France's CAC indices were off 37% and 29% respectively, compounded by rights issues that depressed prices.
Such spectacular falls were bound to be followed by a rally, as occurred in October, with these indices gaining 13.9% and 13.4% respectively. This has recouped losses in only a very limited way, leaving value in some stocks in the market.
Can the recent rises be sustainable? Recent economic news emanating from Europe has, on the whole, been disappointing. Germany, in particular, has looked sickly. The IFO index of German business confidence has fallen for the past five months. GDP growth is poor and barely registered above 0.1% annual growth at the end of the second quarter of 2002.
The recent election result, with a strong green representation, is unlikely to bring about swift economic reforms and may even lead to increased environmental legislation. This does not bode well for a country heavily dependent on exports that is already suffering from a strengthening euro and a weak global trading environment.
The European Stability Pact, which limits eurozone governments to borrowing no more than 3% of GDP, has limited Germany's room for manoeuvre. Some observers are calling for a slackening of the rule to take into account the economic cycle.
Undoubtedly the base rate set by the European Central Bank is currently too high for the German economy. This is damaging since weakness in Europe's largest economy can only be a drag on the rest of the continent.
The problem lies with eurozone inflation, which remains stubbornly above the ECB's desired ceiling of 2%. The 7 November decision to hold rates at 3.25% suggests the ECB is still more focused on monetary stability and a desire to gain credibility for the fledgling euro than it is in promoting growth.
In defence of the ECB, growth among some of the eurozone countries is still quite strong. The IMF expects Ireland, Spain, Greece and Luxembourg to all grow above 2% this year, while all the eurozone countries, with the exception of Portugal, are predicted to grow by more than 2% next year.
There is also an argument that the ECB has to maintain a tight monetary policy to force eurozone countries to engage in economic reforms that might be sidelined if monetary policy were more expansive. Equally, the ECB is keeping its powder dry, allowing for greater manoeuvrability in the future.
The sell-off this year has been so sharp that some shares have moved to attractive valuations. Criticism may be levelled at some of Europe's economic policies, but there are still plenty of quality companies in Europe that are resilient enough to ride through the current difficulties and offer excellent profits expansion when the economy recovers.
Renewed management buyouts and corporate activity suggest insiders are beginning to see value in the market. The recent move by Vodafone to bid for Cegetel seems to have breathed a spark of life into the market. Once sentiment begins to turn, pressure will be removed from the life assurers and markets could recover quite sharply.
Meanwhile, the economic climate remains mixed and, more than ever, careful stock selection is the key to investing successfully in Europe.
ECB keeping its powder dry.
Growth rates still robust in some states.
Corporate activity may bring good valuations.
Stock issuance is depressing prices.
German economy a drag on rest of Europe.
ECB's blinkered focus on monetary stability.
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