The second quarter of 2003 has seen a tremendous surge in global equity markets and Europe has been ...
The second quarter of 2003 has seen a tremendous surge in global equity markets and Europe has been at the forefront of this recovery. During the first half of the year, the FTSE Eurotop 300 (ex UK) has risen 10.8% in dollar terms. This compares with a rise of 7.7% for the US Dow Jones Index and 4.6% for the Japanese Nikkei 225.
The first question must be why equity investors have been attracted to Europe in particular. Secondly, and more importantly still, is whether such outperformance can continue during the second half of the year.
To some extent, the answer to the first question is based on the notion of investors seeking value in economies currently performing poorly but where recovery potential is high. For business as a whole, demand remains weak but there has been considerable evidence to suggest that companies are finally taking the necessary action in terms of cost reductions. In the event of a global recovery, such companies should experience a sharp rebound in profitability. While this is the same the world over, European stock markets have suffered disproportionately during the downswing and as such look set to experience a relatively strong rebound.
With companies now reporting more stable capital returns, investors have begun to anticipate a new cyclical upturn encouraged by lower interest rates. Industrial companies therefore have been particularly strong in Germany and Holland. Even strength in the euro versus the dollar, which continues to depress industrial earnings in the short term, has failed to deter investors now prepared to look ahead to 2004 when improvement looks set to take hold.
It may be argued, then, that much of Europe's recent strong performance has resulted from the realisation that companies have been active in improving returns and that the conditions are now in place for a recovery to take place.
However, for stock markets around Europe to continue to perform strongly from hereon now requires some evidence that much needed top line growth is beginning to materialise, and that companies are at last beginning to see higher levels of demand than in the past. In this respect, the key issue appears to be whether US economic policy is beginning to work so that we may experience an acceleration in US GDP during 2004.
In my view, from current economic data, there is sufficient evidence to suggest that US GDP growth will in fact exceed 3% for 2004.
This alone would provide the opportunity for profit improvements among a significant number of European companies. Furthermore, there is now the growing likelihood of a significant reduction in taxes in Germany during that year which should also serve as a stimulus to both Germany and its surrounding economies.
Therefore, to a large extent, our argument for continued European stock outperformance throughout the remainder of 2003 still relies heavily upon expectation rather than hard evidence of improvement in the current earnings picture.
European companies prepared to cut costs.
US will stimulate European growth.
Europe will benefit from global pick-up.
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