In the year to date, Europe has seen one of the worst falls of the major global indices, driven by...
In the year to date, Europe has seen one of the worst falls of the major global indices, driven by negative earnings momentum, fears of recession and corporate malfeasance.
Investor confidence was shattered earlier in the year and we are now rebuilding it.
Almost 80% of European companies that have reported this quarter have seen earnings in line or in excess of analyst expectations. Positive surprises have outweighed negative by a ratio of three to two, which in itself may not seem that compelling.
More supportive, however, is the fact the positive results came from the large multinationals ' Nokia, SAP and Unilever, for example.
Despite this positive backdrop, analysts have taken the opportunity to reduce earnings estimates during the third quarter reporting season, narrowing the gap between bottom-up and top-down forecasts. As we head into the fourth quarter, year on year comparisons become far easier. The fourth quarter reporting season could well mark the turning point in earnings momentum.
Market relative valuations are at historic lows. Both relative to bonds and cash, equities are at levels not seen since the 1970s. European markets are discounting an earnings decline in excess of 20%, in contrast to both top-down and bottom-up expectations for an earnings recovery.
Recent comments from the ECB suggest despite its apparent intransigence to act in concert with other central banks, we might well see policy easing before year end. With the euro sitting above parity against the US dollar, concerns over export prospects for European industry are more apparent, not to mention the deflationary impact.
The ECB will be reluctant to allow the euro to strengthen from here so erosion of competitiveness in the export sector might be avoided. In addition, Germany poses a big problem for the ECB, representing almost 30% of eurozone GDP, and one that is difficult to ignore.
The biggest risk to the region is the the prospect of deflation, driven by Germany. Continuation of a low-growth, low-inflation environment is a more likely scenario. Germany continues to give a false impression of life elsewhere in the eurozone.
Retail sales, for example, collapsed in Germany but held up well in the rest of the region. Although the ECB will probably cut interest rates in the coming weeks, it will likely not be aggressive enough to return Germany to trend growth. As a consequence, we believe German 2003 GDP could hit the low figure of 1%.
Equity issuance could be a potential drag on the market. At the beginning of the fourth quarter, we were expecting issuance equating to approximately 2% of market capitalisation. To date, we have seen only a fraction of that.
Funds still appear to be overweight bonds relative to equities. Many European insurers have already reduced their equity exposure. With just over 30 trading days to year end, it is difficult to see where the net sellers of equities will come from, particularly in an environment that suggests there is an increased chance of monetary policy easing.
ECB expected to cut rates.
Relative valuations at historic lows.
Earnings momentum close to turning point.
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