Fund manager's comment/John Botham
The unexpected decision by the European Central Bank (ECB) to cut interest rates in May reflected its growing unease about the spillover effect of the US economic slowdown. First quarter GDP growth in both France and Germany was weaker than expected, rising just 0.4% and 0.5% respectively from the previous quarter, although poor inventory and construction sector data negatively distorted those results.
More recent data for Germany, the region's largest economy, has also been less than encouraging: business confidence fell for the 10th month in a row, industrial production contracted by 1.2% and the unemployment rate rose for the fourth consecutive month to 9.3%. The ECB's dilemma, however, is that regional inflation remains persistently above its 2% target: consumer prices in April rose 2.9%, a five-month high, due to sharp increases in food and energy prices.
This deteriorating scenario resulted in a weak equity performance in regional markets in May. The Dow Jones Eurostoxx index was down 2.01% (compared to a 0.51% gain by the US S&P 500), and the euro's weakness against sterling and the US dollar meant heavier losses still for some foreign investors.
Cyclical stocks, which drove April's gains, turned in a mixed performance as apprehension grew about second-quarter earnings in the technology-related sector. Basic industries like forestry and paper, as well as service cyclicals like autos, remained relatively robust and defensive stocks staged a comeback after lagging in April.
Tech and telecoms stocks were the worst performers: Alcatel, the French telecoms equipment company, forecast a big second quarter loss.
The IPO calendar is beginning to pick up. Deals have been reasonably priced and are selling well: Inditex, the Spanish fashion retailer that owns the Zara and Mango chains, was fifty times oversubscribed and shares closed 22% above the launch price at the end of the first trading day.
However, Prada, the Italian fashion house, announced it would delay its much-anticipated IPO, possibly reacting to investors' cautious mood towards luxury goods.
Markets have reached a turning point. Earnings expectations are now much more realistic and big downgrades are slowing. We are moving away from defensives towards growth stocks, particularly those in the consumer cyclical and industrial sectors, on expectations that global growth will pick up.
We plan to maintain our underweight position in technology, focusing primarily on media as purer technology stocks are looking expensive after a good run. Nevertheless, we expect markets will remain volatile in the near term, trading within a range, though biased towards the upside, until clearer global signs emerge.
Earnings expectations more realistic.
IPO market is starting to pick up.
Weak currency a positive for markets.
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