The recent terrorist activities in the US threw not only European but all world equity markets into ...
The recent terrorist activities in the US threw not only European but all world equity markets into a tailspin. Talk of global recession and military retaliation by the US led to indiscriminate and intense selling across all sectors of the market and an emotional state among investors that was clearly divorced from economic and corporate fundamentals.
Similar historic events such as the Gulf War and the Cuban Missile Crisis have shown that business and consumer confidence reach their low points within two months of such events occurring and that it has always been right to buy equities at that point in time.
Continental European equities fell 6.1% within two weeks of the attacks on 11 September and by 35% since the start of the calendar year 2001. At current levels, European equities are cheaper relative to bonds than at any time over the past 20 years.
Overall, the valuation of European equities on a number of measures is extremely compelling. The prospect of further interest rate reductions will underpin current valuations, while a reversal of the extremely poor investor sentiment would provide prices with an upward push.
In the 12-months to early August 2001, continental European markets, as measured by the FTSE World Europe ex-UK Index in sterling terms, fell by around 18%.
Uninspiring results from Ericsson and Nokia, combined with further weakness of the Nasdaq Index, were large contributors to the sharp decline in the technology, media and telecommunications (TMT) shares in the fourth quarter of 2000 and first quarter of 2001. Apart from profit warnings of TMT companies, the fall was exacerbated by short-selling from hedge funds. This oversold technical position enabled the technology sector to recover 38% by 7 June 2001, before the deteriorating earnings outlook reasserted itself and European TMT stocks headed back towards previous lows.
Defensive sectors such as pharmaceuticals, construction, food manufacturing and utilities continued to be heavily bought by investors irrespective of valuations, which are currently standing at or near historic highs.
The manufacturing sector remains perilously close to recession while orders for industrial goods have all but ground to a halt, reducing the visibility of corporate earnings. Against this, there continues to be strong support from consumers and healthy levels of public consumption, which should collectively facilitate GDP growth of around 1.5%-2% in 2001, notwithstanding events in the US.
The latest easing of the key official interest rate by 50bp to 3.75% by the European Central Bank is modest but further aggressive monetary easing is now likely following the sharp fall in inflation in recent months.
Consumer price inflation currently stands at an annualised rate of 2.6% and is rapidly heading towards the important target level of 2% per year. Although 9% above its low, reached in late October 2000, the euro/sterling rate is still 12% below its level of 1 January 1999, with the consequent translation effect of European equities for sterling investors.
Equities cheap relative to bonds.
Valuations are compelling.
Consumer confidence remains strong.
Uncertainty over global recession.
Manufacturing sector close to recession.
GDP growth estimates down.
Dino Fuschillo is head of European equities at SG Asset Management
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