Europe's stock markets are being pulled in different directions by opposing forces. Pulling in one d...
Europe's stock markets are being pulled in different directions by opposing forces. Pulling in one direction is the prospect of a worldwide easing in monetary conditions; pulling in the other is the deteriorating trend in companies' earnings.
In the past, the direction of interest rates and inflation have proved more important for equity investors than the direction of earnings. So we can expect the trend in the revisions of corporate earnings in Europe to follow that of the US. There, 70% of all revisions until the middle of 2000 were upgrades, before the proportion plummeted to 28% by the end of the year.
In January, data bounced off its low, hinting at a possible turning point in the earnings cycle. But it is likely that investors will need to see evidence of stability in the leading indicators before they regain a genuine appetite for risk.
For European markets, there are two main issues.
First, is the long-term growth rate of the US economy 4%, or closer to 2.5%? In other words, will the productivity gains driven by technology continue to drive economic growth, or are they merely a function of it?
Second, is the world's telecoms industry in danger of being derailed by the mountain of debt it has built up?
As a backdrop to these issues, two further dynamics will affect the cycle of Europe's stock markets. First is the degree to which Europe's economy is protected against trends in the global economy.
This has allowed unemployment in Europe to fall in recent months. The solvency of Europe's private sector balance sheets, little overhang of inventories and the increasing pace of deregulation are probably the main reasons for this. Ironically, such strengths may encourage the European Central Bank (ECB) to maintain a more conservative stance on interest rates.
The second dynamic is the oil price, which has a direct impact on the euro's exchange rate and the headline rate of inflation.
It is clear that central bankers are now on a reflationary path. This follows a period of 18 months during which central banks' monetary policies were too loose in the run-up to Y2K and then too tight in response to a rise in the oil price which has proved to be neither deflationary nor inflationary. In future, investors can expect the ECB to be less proactive in lowering interest rates than the Fed or the Bank of England, but the trends in inflation and interest rates should support equities during the rest of 2001.
A further positive is that there is clear evidence of an effort to control the oversupply of product and services in industries as diverse as steel, hotels and semi-conductors. A falling oil price and rising liquidity in stock markets should help to raise investors' appetites for risk.
Mark Pignatelli is head of European Equities for Schroder Investment Management
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