Recent indicators point to signs of stabilisation of economic growth across the region, although so ...
Recent indicators point to signs of stabilisation of economic growth across the region, although so far inventory correction and government spending have shown stronger rebounds than industrial production and the all-important consumer.
The breakdown of the IFO survey, which showed surprisingly strong February and March indications, based largely on future expectations, concurs with our view that sustainable growth may not be achieved until later in the year.
The inflation outlook remains benign despite the blip earlier in the year caused primarily by food prices and re-pricing of some goods and services during the euro changeover.
Indeed, producer price inflation has dropped quite sharply and we see no reason to change our expectation that consumer price inflation will be sub 2.0%, below the ECB reference value, by the summer. At the review of the Stability Programme at the beginning of this year, countries reaffirmed their determination to balance government budgets by 2004. We doubt that the largest Euroland countries will achieve this goal (estimating between 1.5% and 1.8% deficit in 2002) but expect governments to press ahead with fiscal consolidation, reaching budget balance possibly with a year or two of delay.
On short-term interest rates, we expect the ECB to move rates higher by about 50bp but only later in the year and after the US has acted. At the longer end, we expect the 10-year yield to stabilise at around 5.0% by the year-end.
Estimates of corporate profits growth show more than the usual divergence between top-down macro drivers and bottom-up analysis projections. The range of about 5%-30% for 2002 is explained by a mixture of varying GDP assumptions, base effect, accounting inconsistencies and so on.
The ratio of downgrades to upgrades has started to improve but we feel that it will not be until summer at least that hints of optimism are reflected in real company statements. The IT sector continues to be dominated by worries on debt, uncertain strategic future and the outlook for demand for many products.
Only by historic comparison with government bonds can European equities be described as outright cheap on current bond yield and earnings growth assumptions. On P/E, price/ cashflow, dividend yield or EV/EBITDA ratios, the overall market appears more fairly valued. The aggregate P/E of approximately 20 falling to 17 for 2003 is interestingly not too dissimilar to the UK or US, but as stressed above, sample and accounting differences needs to be respected.
Other factors to consider are the longer-term demand for equities as continental retail and institutional investors continue to increase stock weightings from low levels out of cash, bonds and property. The supply side has been weak recently but governments, corporate and debt ridden Telcos will use any opportunity to satisfy this demand.
On balance, Legal & General is neutrally weighted towards European equities from an asset allocation point of view. Within our funds, we are maintaining higher than average weightings in industrial cyclicals (more software than hardware).
Signs of stabilisation of economic growth.
Fewer corporate downgrades.
Benign inflation outlook.
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