The optimism I felt earlier in the year concerning reform in Europe and subsequent outperformance of...
The optimism I felt earlier in the year concerning reform in Europe and subsequent outperformance of European stocks has been dealt a blow by recent economic and market turmoil.
The anticipated evolution of tax, welfare and savings systems in a more market-oriented direction is proving almost impossible to achieve during the current atmosphere of crisis. In place of these potentially major improvements, the existing rigidities of the eurozone have again attracted the attention of investors.
Markets like Germany and France have recently been among the laggards of the developed world.
Two structural problems stand out. First, we have been frustrated by the European Central Bank's unwillingness to reduce interest rates in order to stimulate demand. Its desire to build an inflation-busting track record is creditable but the threat of a recession should surely be more pressing.
Second, the stability pact that restricts fiscal deficits is exacerbating the economic cycle as governments are encouraged to reduce their spending in line with falling tax receipts.
History would suggest stimulating growth by higher government spending is more appropriate when demand is falling elsewhere in the economy. US monetary and fiscal policy has certainly been more proactive over the past year.
In terms of the economic cycle, the absence of export recovery has revealed the weakness of final demand across the region. Consumer frustration with a rise in prices following the adoption of the physical euro has been blamed. I would rather attribute the weakness of consumer spending to the obvious job insecurity, but also to pre-occupation with under-funded pensions.
In the long term, this need to save will create some great investment opportunities, as a lot of money will flow into structured savings products. At present, it deters the borrow-and-spend mentality that is sustaining US consumption and therefore hinders Europe in generating its own economic growth.
European stock markets have also had to cope with the drag of forced selling of shares by insurance companies. The falls in value of their equity portfolios, coupled with some heavy underwriting losses in 2001, have put pressure on the solvency of some such businesses.
Recently, this forced selling has caused something of a downward spiral in the market. Insurers, by contrast, were a major source of buying pressure throughout the 1990s.
Recent news that insurers' equity exposure has in many cases been sold or hedged is very welcome.
This more cautious economic and market outlook should not overshadow Europe's attractions. First, many of the consumption and accounting excesses of the bubble period in America were not repeated in Europe, a fact that has still not been reflected in relative stock market valuation or performance.
Second, looking further out, structural reform is being deferred rather than cancelled. Nations within Europe's uniform fiscal and monetary system have to improve their competitiveness to attract investment. This will result in a better environment in which to do business and will increase returns on capital across the economy.
Third, Europe's global leaders in sectors like pharmaceuticals, cars and software look very attractive to the long-term investor, both relative to other regions and in the absolute.
Europe has avoided the extremes of America.
It remains a cheaper place to invest.
Structural reform no longer expected.
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