Despite its relative resilience the European economy is obviously not immune from the deterioratin...
Despite its relative resilience the European economy is obviously not immune from the deteriorating global environment.
Europe's trade exposure to the US is limited compared to most other regions, but weaker foreign demand will obviously have some impact. Conversely, there should be some positive effects from lower interest rates and lower commodity prices. Consumer spending, which represents nearly 60% of GDP, should also hold up fairly well, aided by income tax cuts in France, Germany, Italy and the Netherlands, provided unemployment does not increase significantly.
The current economic environment in Europe should really be viewed as more of a mid-cycle slowdown. Europe is arguably at the start of its own productivity revolution, where structural reform at governmental and corporate level is creating a vibrant backdrop that is encouraging European companies to make increasing investment, specifically in the information and communication technology (ICT).
The slowdown in the European economy has broadly been under way since the middle of 2000. However, the European Central Bank (ECB) has been unable to ease interest rates thus far because of the deteriorating inflation background caused by the euro's weakness and the high oil price. Despite headline eurozone inflation of 2.6% year-on-year being well above the ECB's target ceiling rate of 2%, in the current background it now seems appropriate to be expecting imminent monetary easing.
Other data to focus on is money supply growth, which has been slowing, core eurozone inflation, which is below 2% and fairly stable, exports, which are slowing dramatically, and softening leading indicators. This backdrop, in addition to the slowing in the global economy, means that co-ordinated global easing of monetary policy now appears likely.
The medium-term outlook for the euro appears healthy. We are looking for appreciation to parity against the US dollar over the balance of 2001. This view is based on Europe's more resilient economic growth, interest rate differentials moving in Europe's favour due to less pronounced monetary easing from the ECB and a slowdown in FDI outflow from Europe. Valuation levels of European equities have improved dramatically over the past few months, helped by lower bond yields. This should prove to be a good entry point for buying European stocks. On a historic basis, the current equity yield ratio is close to the lowest levels seen over the past decade. The expected steepening of the yield curve should result in rising share prices and we would expect the more economically sensitive, cyclical sectors to outperform defensives in this environment.
Our preference is for the cyclical service sectors such as leisure and hotels, as well as the more cyclical end of the technology sector such as the semiconductor-related companies.
Adrian Fowler is head of European Equities at Aberdeen Asset Managers
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