Following the introduction of the euro in January 1999, the eurozone is now the second largest singl...
Following the introduction of the euro in January 1999, the eurozone is now the second largest single currency equity market in the world. However, these equity markets are still relatively underdeveloped.
The advent of the single currency is likely to further develop the cult of the equity within Europe. As liabilities are now denominated in euros, all equity assets within the euro area will now be viewed as eligible investments. The result will be a significant rebalancing of funds in order for investors to diversify their risk. For example, German institutions will now gain exposure to oil stocks in Holland while Spanish investors will be able to purchase electronic companies in Germany.
Moreover, small countries such as Ireland, which represents less than 2% of the European market, will gradually start viewing the rest of the eurozone as its area for potential investment opportunities. The appetite for overseas investments is already well developed in Holland but predictably the cautious Germans have only a modest exposure overseas.
An ageing European population is creating a doomsday scenario whereby all eurozone countries are urgently reviewing the scope for unloading their future pension liabilities onto the private sector. The result will be a substantial increase in equity investment.
The need to become more competitive within Europe has become more pressing following the advent of Emu. As goods become priced in one currency, price transparency will become much more evident, resulting in prices gravitating to the lowest level in Europe. This will create both threats and opportunities to companies. Less efficient businesses will be disadvantaged whilst those companies which can cut costs and improve operating efficiencies will benefit from a much larger market.
Hence the huge merger and acquisitions (M&A) and restructuring activity which shows no sign of abating. In 1998, European M&A activity grew by 60% in value terms over 1997. The bulk of this actively is concentrated in larger capitalisation stocks where both cost and marketing synergies are substantial.
European stock markets have proved to be lacklustre performers since the beginning of the year partly reflecting faltering economic growth in Germany and Italy. In addition, the spectre of further interest rate hikes in the US is undermining European stock market confidence.
However, economic growth expectations are improving in Europe helped by recent euro weakness and more synchronised world growth
In conclusion, European equities are viewed as an attractive asset class both in terms of growth prospects and also on a valuation basis and large capitalisation companies are favoured over small companies given their greater, exposure to the benefits of M&A activity.
Tony Zucker is fund manager at Thames River Capital.
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