The eurozone economy has been treading water for some time. GDP growth ground to a halt in the first...
The eurozone economy has been treading water for some time. GDP growth ground to a halt in the first quarter, following a paltry 0.1% quarter-on-quarter rise in the fourth quarter of last year.
The slowdown in eurozone growth reflects weaker global demand, coupled with the appreciating euro denting export growth. Forward-looking economic indicators have yet to paint a significantly better picture.
Despite the easing of geopolitical uncertainty after the war with Iraq, eurozone business surveys have improved only slightly in recent months, with the key eurozone PMI surveys for manufacturing and services below the 50 expansion level.
To stimulate economic activity, the European Central Bank (ECB) has cut interest rates to 2% and, with core inflation comfortably below its reference rate, there remains plenty of scope for further interest rate cuts.
Despite mixed economic indicators, investors have proven willing to look through current weakness in anticipation of a period of stronger growth. As a result, since the March lows in equity markets, defensive sectors with stable and predictable cashflows have lost their allure.
With the war behind them, and encouraged by generally better-than-expected company results, investors' tolerance for riskier assets has improved markedly. Consequently, sectors that had previously lagged, such as financials and technology manufacturers, have notched up some of the largest gains.
Recognising that the end of the war would probably trigger a step-change in investor psychology, we have trimmed or removed holdings we would characterise as defensive growth stories. The proceeds have been used to increase exposure to stocks sensitive to an economic recovery. Key examples include Siemens and Sandvik, the Swedish manufacturer of cutting tools.
At the same time, we continue to look for shares that are languishing and that we believe offer some recovery potential. In these circumstances, provided we can identify a catalyst that is likely to lead the market to re-evaluate the stock, we will take a position.
We have bought into Ahold, the Dutch food retailer, which admitted accounting irregularites in February. We feel the stock is undervalued by the market and is likely to be re-rated.
In a similar vein, we have returned to German engineering company Linde, which we sold earlier this year, as our analysis suggests the stock is at the early stage of a recovery.
For the specialist investor, European smaller companies have considerable appeal, with valuations particularly attractive at present compared to large companies. As smaller companies tend to source a larger proportion of their earnings from within the eurozone, the weaker dollar will have less of an impact on profits, a fact that further increases their appeal.
Recent rate cuts in the US and Europe have confirmed that global economic policy is firmly focused on stimulating a recovery. After a quiet summer, we believe economic news will show a consistent improvement.
Scope for further interest rate cuts.
Valuations looking attractive.
Companies becoming more efficient.
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