Last year was a relatively dull time for European equities, especially when measured against the imp...
Last year was a relatively dull time for European equities, especially when measured against the impressive record of recent years. The main story was the extreme polarisation of returns: while defensive sectors flourished, technology and telecoms suffered severe setbacks, with the Neuer Markt Index retreating around 70% from its peak. Ironically, while the current mood is much more cautious than 12 months ago, we believe market prospects are now more encouraging.
European economic prospects appear favourable, especially in comparison with the anticipated sharp deterioration in the US. Growth is expected to slow to around 2.5% in 2001 and inflation should emerge close to the 2% target level, helped by recovery in the euro and stable oil prices. While lacking the Fed's boldness on interest rates, the European Central Bank could lower the cost of borrowing later in the year.
The 1990s was a decade of dramatic change for European business, epitomised by the elevation of shareholder value as the prime management objective and the accelerating pace of corporate restructuring/merger and acquisition activity.
Rising share prices, coupled with extensive marketing campaigns for privatisation issues, have generated a growing appetite for equities among Continental retail investors. Although hurt by the fall in the prices of technology shares, European savers have continued to buy substantial equity based mutual funds. This implies that they have not lost their nerve and that they will respond to new opportunities. Looking ahead, official moves to encourage individuals to save for their retirement via mutual funds or funded pension funds are likely to feature in the news. There are some notes of caution to inject into the debate in the short term, although these relate more to tactics than investment strategy.
In first place, a US recession and further weakness on Wall Street would inevitably have an impact on other stock markets, including those in Europe. The possibility of renewed pressure suggests that caution should be exercised, both in maintaining a reasonable cash position and in not being too anxious to take profits on defensive sectors.
The Orange flotation in February will pose a particular test for European markets. As both a substantial issue (around £8bn) and as part of the out of favour telecoms sector, much depends on generating a positive response and maintaining a favourable after-market.
There are a number of other telecoms IPOs waiting nervously in the wings. A poor response to Orange would inevitably lead to postponement and disappointment for other issues.
The recovery of the euro, which began in the final quarter of last year, looks soundly based. It could strengthen further, especially if pronounced US economic weakness undermines the fortunes of the dollar.
Susan Smith is head of European equities at M&G
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