After a period of equity market weakness early this year, European markets are becoming more realist...
After a period of equity market weakness early this year, European markets are becoming more realistic, both about corporate earnings expectations and valuation, although it is probable that analysts' forecasts for company profits will see further downgrades.
Earnings will probably be under more pressure in some sectors, especially given the economic headwinds of slowing growth, tighter credit conditions, and softer industrial and consumer confidence.
In the medium term, there are two main factors we believe will support European growth. One is that European consumers generally have lower levels of debt than their US and UK counterparts. Also, that debt tends to be at long-term fixed rates of interest, meaning European consumers are much less sensitive to fluctuations in short-term interest rates.
Secondly, we see the widening of EU membership as a potential support for long-term growth. We see this as providing both a stimulus to demand and to the supply side of the European economy as many of the newer EU members are relatively low-cost producers.
Equity markets have moved on from the easy monetary conditions that favoured those companies with financial leverage, and strong global growth, which provided a boost to those with high operational leverage.
In future, slower economic growth and tighter credit conditions should herald a return to more appropriately priced risk in financial markets. We expect companies with sustainable earnings and sound balance sheets to perform better than the market average. Large, well-capitalised blue-chips have seldom looked cheaper after their neglect during the 2003-2007 rally.
We remain wary of having too high an exposure to banks. They have already underperformed the market since the problems in credit and money markets emerged in mid-2007, but it remains too early to call the bottom in the sector as a whole.
Overall, companies with good earnings visibility and healthy balance sheets are likely to do well. This means we continue to overweight sectors like telecoms and pharmaceuticals along with stocks in a range of sectors offering relatively robust growth at a reasonable valuation.
- European consumers are less indebted than their UK and US counterparts
- Widening of EU membership a potential growth support
- Macroeconomic headwinds remain and further earnings downgrades are likely.
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