Equity returns in Europe have proved to be a huge disappointment in 2001, with declines in excess ...
Equity returns in Europe have proved to be a huge disappointment in 2001, with declines in excess of 20%, in sterling terms, registered for the major indices so far for the year.
The economic fall-out from the US and the subsequent negative impact on corporate earnings has forced the world's monetary authorities, led by the US Federal Reserve, to cut interest rates aggressively and relax fiscal policy significantly. The question now for investors is whether this monetary and fiscal stimulus will have the desired economic effect and provide a base for recovery next year.
With the markets having rallied from their September lows, the expectation is that the policy initiatives will work. We believe economic growth will return in the second half of next year because of the lag between changes in monetary policy and their economic impact.
Inflation, always a potential threat to financial market stability, does not appear to be an issue at the moment. With the oil price in decline and the euro appearing to have found its base, economic conditions now look to be on a sounder footing. As a result, we expect interest rate policy to remain accommodative for the foreseeable future.
On the corporate front, Europe appears to be in better shape this time around as compared to the last recession. Debt levels do not appear to be overly burdensome, particularly given the current low level of interest rates. Management also appears to have a tighter control over inventory levels and enhanced flexibility over labour costs. The pace of corporate restructuring is clearly improving and this augues well for profitability going forward.
Europe is about to undergo some significant and far-reaching changes at the start of next year. The impact from tax and pension reforms due to come into effect in Germany should not be underestimated.
These reforms are likely to redefine the corporate landscape in Germany as the removal of capital gains tax provides the catalyst to move away from the current conglomerate model. M&A activity should pick up significantly as corporates are given the opportunity to unlock hidden reserves and redeploy this _dead capital' to core activities. The overall effect we are likely to see is a more efficient use of capital, which will inevitably improve returns.
As with the rest of Europe, pension reform is now a necessity in Germany as the current state system creaks under the burden of a rapidly ageing population. With the onus (through tax breaks) put more on private pension provision, the amount of new capital that flows to the equity market is likely to be considerable.
Finally, will the introduction of euro notes and coins in January have a material impact on the European economies and financial markets?
We have probably already witnessed the majority of increased consumer activity in the _grey/black economy' areas of Europe. The issue now is whether the new notes and coins impinge on retailers and banks over the short term. The long-term benefits will be clear as we begin to see an increase in consumer price transparency across borders.
Monetary policy to remain supportive.
Recovery priced in and no room to disappoint.
Restructuring potential not fully discounted.
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