Fund manager's comment/Michael Nicol
The long-term case for European equities, driven by changes in savings and pensions, looks intact. However, the European economy still looks linked to the US slowdown, with stock markets performing just as badly. Lower interest and inflation rates may result in lower absolute returns in the future, with increased stock market volatility.
After last year's disappointment, European equity markets have fallen further still this year. Stocks in the information technology hardware, telecommunication and cyclical media sectors have led the market down. Concerns over the visibility of future third generation mobile telecom revenues and capital expenditure requirements triggered falls in telecom operators' and equipment manufacturers' valuations. Debt has also emerged as a concern. Many telecom companies now need further financing in the near future. This fear of further share issues has also depressed the sector.
The weakness in the US and Japanese economies will impact European economies. Earning projections in a wide range of sectors have become less visible. Sectors and stocks that benefited from the markets nervousness included defensive growth stocks and stocks with more visible profit patterns. Overcapacity problems in areas such as telecom infrastructure appear more medium-term concerns than short-term. Companies in high debt sectors such as telecom and information technology will require stronger markets to issue new shares or sell non-core parts of their businesses in order to fund future growth. This urgent need for financing from a wide range of companies suggests a range-bound market over the next six months, as companies take advantage of any improvement in markets to raise cash.
Key to market direction will be indications of an economic pick-up, particularly in the United States. Evidence of this would help Europe look beyond the short term, which will be characterised by weakening economic and corporate news.
Stocks with greater visibility in earnings and less exposure to an economic slowdown should still form the core of a European equity portfolio. Information technology stocks, media stocks with high exposure to advertising and telecom stocks continue to be in the danger category. However, that leaves a large part of the market where investment opportunities are available. A mixture of growth and value is available in support service stocks, subscription based media stocks and the oil sector.
Europe will continue to offer good medium to long-term prospects due to a growing equity culture and the potential for efficiency improvements to benefit corporate profitability. Equity markets will also show diverse individual corporate performance, greater volatility and lower absolute returns. All of these will give the active manager more opportunity to achieve above average returns.
Potential efficiency improvements.
Changes in savings and pensions.
Growing equity culture in Europe.
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