Notwithstanding recent bond market weakness, European equities have risen by almost 10% since the st...
Notwithstanding recent bond market weakness, European equities have risen by almost 10% since the start of this year, helped by continued good corporate profitability, improved prospects for European and global economic growth and further corporate restructuring and merger and acquisition activity
Earnings growth is set to rise by an underlying 15%-20% in 1999, GDP is forecast to grow at 2.6% next year (up from 2% this year) and of the largest 100 companies at the end of 1998, more than a third have been involved in major corporate activity so far this year. It therefore seems reasonable to ask whether equities are likely to continue to be supported by such conditions and to look at the factors that might pose a threat to further gains
While economic growth remains an important driver of earnings growth in Europe, it is by no means the sole determining factor, as other positive equity market themes have provided support. There has been an unprecedented level of corporate activity in Europe this year, with France in particular seeing some of the largest deals
Further activity is anticipated and rumours have abounded of a possible merger in the German utilities sector between Viag and Veba. Such a deal would create the largest utility company in Europe, with a market capitalisation in the region of £32bn
Restructuring has also taken hold. In some cases this has involved the sale of peripheral businesses in order to focus on core areas, in others these boundaries have been transcended as companies have almost reinvented themselves. For example, Preussag in Germany, has been transformed from an industrial conglomerate into Europe's largest tourism company
While we anticipate continued economic growth, we expect it to be neither excessive nor inflationary. Inflation is set to remain in check as the renewed strength of the euro will exert downward pressure on import prices. In this environment, bond yields are not expected to rise significantly from current levels and should remain supportive of equity valuations in the medium term, enabling earnings growth to remain in double digits. The risk to this scenario, of course, is that faster than expected economic growth will lead to bond market weakness
Conversely, slower than expected economic growth also poses a threat. Given that further equity gains in Europe are based around expectations of a continued recovery in the fortunes of the global economy, any downside surprises to this scenario are likely to provide a nasty shock to the system. The US in particular presents a danger, as any slowdown in the economy there will be received poorly
While the economic backdrop is likely to remain supportive of European equity markets, the euro is also set to continue its recovery amid further evidence of an economic upturn
David Kiddie is head of pan-European equities at Hill Samuel Asset Management
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