Pessimism of investors harming equity markets

Extreme levels of pessimism are hampering European markets, which are down more than 30% in euro terms over the year to the end of September.

Juliet Cohn, manager of Dresdner RCM's European fund, says: 'Sentiment has reached extreme levels of bearishness and many are attempting to justify why equities will face a fundamental shift in how they are valued.

'The arguments are not dissimilar from those made in 1999/2000 to justify the internet-inspired bubble. The same statistics that two years ago argued for a continuation of the bull market now show stocks are expensive.'

Cohn believes the biggest question investors now face is how much further the market has to fall or whether it has already bottomed. 'The market is driven by sentiment rather than fundamentals and sentiment needs to improve to reverse the bearish trend and drive the market higher,' she says.

Although Dutch telecom group KPN posted a $9bn loss for the second quarter, it gave an upbeat assessment for the year and its shares have rallied 170% from their low point last September, she notes.

Insurance group Axa has announced results ahead of expectations, she adds, as have Ryanair, Inchcape, Unilever, Reckitt Benckiser and Inditex.

'The market is being pulled by weak economic data, although corporate news is not universally bad,' says Cohn. 'In many cases, it is better than share prices indicate. The prospects for further rate reductions and improved corporate newsflow encourage us.

'Many commentators suggest we are locked into a bear market and stocks have further to fall. This makes others nervous of committing funds to equity markets. 'Confidence may be fragile but the risks must now be more on the upside than the downside. Patient investing in high-quality companies with strong positions and good cashflow will continue to yield the best results.'

Some areas of the market have suffered far worse than others, with elements of European technology, media and telecommunications now showing value.

Software companies are attracting greater interest from fund managers than hardware businesses because their price-to- sales ratios have fallen below pre-bubble averages. Many hardware companies also remain value destroyers, with return on capital still in negative territory.

Although some valuations in the telecommunications sector remain cheap, many companies are faced with stiff competition and carry heavy debt burdens.

James Ross, head of European equities at Bernstein Investment Research and Management, says some telecommunications stocks are now cheap.

Ross's European Value Portfolio holds Spanish telecommunication group Telefónica, which, he says, has benefited from the news it has frozen all its 3G mobile phone operations outside its domestic market.

Expensive 3G licences have caused doubts about the future profitability of telecommunications companies.

James Bevan, head of investment management at Inscape Investments, says previous revenue assumptions are suffering due to technology creating new forms of competition.

He feels overall business and growth conditions are not healthy and growing profits are unlikely for many companies.

Joanne Frearson

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