By Alia Baig, head of European equities at AXA Investment Managers In a bad year for European eq...
By Alia Baig, head of European equities at AXA Investment Managers
In a bad year for European equities, markets registered a fall of around 20% in 2001, making it the second consecutive year of negative returns, following a drop of around 5% in 2000.
Historically, a third year of negative returns would be highly unlikely. However, after the extreme levels of market volatility and increasing pessimism that characterised 2001, what can we expect from European equity markets in 2002?
Monetary policy will remain supportive during the first half of the year and interest rates in Europe are likely to decline by up to 50 basis points in the next few months. Structural reform initiatives continue across Europe.
For example, from the start of 2002 in Germany capital gains tax for corporations has been cut allowing industrial cross-shareholdings to be unwound without incurring punitive tax charges. In Italy, measures proposed in the recently approved 2002 budget will finally allow for the establishment of personal pension schemes.
Additionally, the liquidity scenario across Europe remains positive. Apart from relaxed monetary conditions, the savings ratio is high and the prospective return on bond portfolios is low.
Another important factor is earnings expectations or the level of anticipated profitability across markets. Having been a negative consideration for markets for the last two years, it may well now start to be a positive provided expectations have moved down to more cautious levels during 2001. In any event, after a negative 2001, earnings momentum should turn positive during 2002.
Nevertheless, there are still risks. For any upside in equity markets to be realised, the global economy must recover during 2002. There is still a risk that lower interest rates in the US may fail to halt a consumer-led recession exacerbated by rising unemployment. Additionally, the European economic recovery may be delayed if the ECB fails to act in cutting interest rates.
However, under a recovery scenario, our preferred sectors or themes would include companies that are restructuring and refocusing their activities on more profitable areas.
Tactically, for the first quarter we would also highlight cyclical companies that would actively benefit from any upturn in the economy and currently offer attractive valuations. Our least favourite sector remains financials, where companies exhibiting strong business models are few and far between, compounded by the current macroeconomic scenario that will further hamper the sector's profitability. Defensive areas such as food and pharmaceuticals look expensively valued at the moment.
Within our portfolios, we continue to invest in those companies where we feel that the market has underestimated earnings potential, the company exhibits a strong business model and the valuation looks attractive.
For example, Allianz is a beneficiary of German tax reform allowing it to restructure its business and focus on improving its underlying profitability. Similarly, Ericsson is refocusing on its underlying profitability and improving its cashflow generation in an environment where demand in its end markets has deteriorated.
Supportive monetary policy.
Earnings expectations likely to be positive.
Liquidity scenario positive.
Low US rates fil to halt recession.
Rising unemployment exacerabates recovery.
ECB failure to cut interest rates.
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