By Roderick Marsden, manager of JO Hambro Capital Management European Fund Towards the end of 20...
By Roderick Marsden, manager of JO Hambro Capital Management European Fund
Towards the end of 2001, European equity markets began to recover sharply driven by lower interest rates, resilient consumer spending and hopes of an industrial recovery during the first half of 2002.
Perhaps it was asking a lot, but most market watchers expected bourses to push higher in January. They didn't, which leaves us to ponder whether we have merely paused for breath in the early stages of a recovery or something more sinister is afoot.
Of course, the main issues worrying equity markets everywhere are the high indebtedness of certain areas of business coupled with the possibility of a double dip recession. The larger and deeper the current downturn, the more likely there will be a problem with bad debts.
In Europe, this was very much the case in the early nineties where high indebtedness in the property sectors led to a banking crisis and resulted in the withdrawal of credit lines to both industry and the consumer.
Undoubtedly, bad debt provisions are likely to rise in 2002 as corporate failures come to light, so often the case in the early stages of economic recovery. However, banks now appear more likely to weather the storm allowing the early stages of an economic recovery to develop rather than to wither.
While signs of an economic recovery appear to be emerging and it is unlikely that the financial system will impede its progress, we need to consider whether the recovery will be strong and whether it is already adequately discounted in current European share prices.
The case for expecting a healthy European economic recovery this year is based upon the decisive loosening of monetary policy especially in the US and from the fall in the price of oil. In the case of Europe, the introduction of the euro and a lowering of taxes are also adding to consumer buoyancy, which remains a critical factor in the avoidance of a double dip recession and a lurch downwards in European stock markets.
At present such an outcome appears achievable and a return to annualised trend GDP growth of 2% by the second half of 2002 seems a strong possibility. The true euro market optimist would argue that structural reforms might also contribute to additional growth from the middle of this year onwards. At this point in time then, it would seem that Europe appears in a sufficiently strong position to return to a respectable level of growth by the middle of the year. Sluggishness in the first half, however, will mean that company earnings are only likely to grow by something in the region of 5% during 2002.
With the overall prospective price earnings ratio for the market currently estimated at 18X, share prices appear to be fairly valued. Of course, that is not to say that deep pockets of value cannot be unearthed within the European markets but in the first half of this year these are more likely to be found in industries where restructuring and rationalisation programs are already well under way.
Well managed companies in the traditional sectors such as paper and packaging, engineering and other industrial businesses, as well as in retailing, appear to offer value here.
Consumer spending to remain resilient.
Exports to improve as US recovers.
Traditional sectors offer good value.
Consumption likely to fade.
High growth sectors still in disarray.
High debt levels in certain areas of business.
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