After three years of negative returns from European equities, M&G is one investment house that belie...
After three years of negative returns from European equities, M&G is one investment house that believes the only way is up for continental markets.
The seven-year bull market enjoyed from the early 1990s has unwound in spectacular fashion over the last three years but many European stocks are now oversold, according to John Hatherly, head of research at M&G Investments.
While the majority of European companies' revenues are generated on the continent, a number of blue chips are still paying the price of aggressive overseas expansion at the top of the market. Hatherly says: 'The poor performance of the last three years has been down to the unwinding of the previous seven years when people got too enthusiastic and the bigger companies in Europe were some of the most aggressive acquirers of North and South American assets.
'We have seen a change in the way companies are run though, with greater attention to shareholder value, cost-cutting and restructuring. Valuations are more reasonable now, but debt levels remain high and need to be worked through.
Hatherly remains bullish on the Europe story, citing such long-term positive trends as demographics, the need for individuals to invest for their pensions and the maturing capital markets.
Michael Saunders, an analyst at Schroder SalomonSmithBarney, warns any recovery in the European equity markets could be tempered by the continued appreciation of the euro versus the dollar.
Saunders says: 'The ongoing strengthening of the euro is threatening to offset, at least partly, the expansionary effect of the 5 December ECB rate cut. If the appreciation of the euro persists in coming months, chances of a rate cut, which already exceed those of a rate hike, would mount.'
He notes last year's fiscal easing measures helped spark an increase in household borrowing, but have done little to stimulate business borrowing.
Saunders adds: 'Financial conditions faced by households and businesses are historically easy, but do not reflect the euro's appreciation any more than they did a year ago.
'Against this backdrop, another jump in the euro would harm total demand prospects enough to warrant additional monetary easing, unless by that time consumer spending has taken off.'
The currency has been attacked by a number of commentators in the eurozone, particularly those in the poorest performing economies of Germany and Italy, as a major cause of the region's woes, notes Hatherly. 'Euro or no euro, continental Europe would have been the weakest market last year. The problem is not the currency but the single economic zone. When applying the same interest rates to all countries you need to compromise but it is difficult to implement a one-size-fits-all policy,' Hatherly notes.
'For example, the Netherlands and Germany's growth rates are very low, but Spain and Ireland are a lot higher. The eurozone interest rate is currently 2.25%, but Ireland could do with rates over 4% and Germany nearer 1%.'
The strength of the euro over 2002 did have an upward impact on eurozone inflation as the currency appreciated 15% against the dollar, Hatherly adds.
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