Relative to other developed markets, Europe has come through the first half of the year pretty well ...
Relative to other developed markets, Europe has come through the first half of the year pretty well although investors would have done just as well sitting smugly in UK gilts.
The outturn is a shade disappointing given that Europe is in the early stage of an economic upswing that should see GDP growth of at least 3.5% in the current year and estimates of corporate profits are being raised steadily.
The recent hike in interest rates is unlikely to damage prospects for this year though it is likely to shave estimates for 2001. The ECB's bold move to increase the repo by 50 basis points to 4.25% and move to a variable tender surprised the market. It should not have done so for monetary conditions have probably been too easy for too long. The rise breathed a bit of much-needed life into the euro but the authorities were probably eyeing a hardening of core inflation rather than the currency when they made their decision.
The ECB has clearly reminded markets that it is the ultimate regulator and bond markets have taken the hint and seem now to be confident of another 50 basis points rise before the end of the year.
On the other hand further surprises on the inflation front cannot be ruled out - especially if oil prices continue to harden and a resurgent euro breeds an increase in consumer expenditure. Over the next few months there will be a bit of a struggle between the forces of higher inflation and the resolve of the ECB with the result determining the pace of economic growth. Until further hard data arrive as evidence it is safer to reckon 3.5% growth as the top. This means that corporate earnings are going to be the main determinants of market movements.
As far as Europe is concerned, apart from their new economy status tech, media and telecoms differ from other cyclicals in that they will still enjoy a fair measure of pricing power.
We would be looking for some return of cash to equity mutual funds later in the summer after the recent sharp drop in inflows. It is less easy to be confident of continuing support for European equities from US buyers. The inflow is still positive but the trend is noticeably downwards. As the euro strengthens against the dollar inflows from the US may be further restricted until investors can be more certain about the longer-term merits of holding European assets.
In market terms Europe is still lagging other developed regions and should prove marginally stronger in the current year. Tying in corporate earnings estimates to markets and assuming all other things are neutral the end of the year should see European equities returning in the region of 12%. This argues in favour of any deviations from neutral positioning being on a strictly opportunistic basis.
Maureen Hemphill manages the Murray European Fund for Murray Johnstone in Glasgow
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