Slow economic growth in Europe has been the feature of the first half of the year when compared to th...
This has been the major factor behind the weakness in the euro since its creation, which has undermined returns from the region as reasonable local gains have been eroded by the currency's depreciation. For the second half of the year, however, we feel there is evidence that European economic growth will accelerate and improve its growth profile relative to the rest of the world.
While some economies, such as Spain and Ireland, continue to experience buoyant growth, the core European economies have been more sluggish. With France now showing signs of a more sustainable recovery, the focus of attention has been on the German economy and its perceived failure to expand.
We feel that since Germany is Europe's largest economy and more exposed to export markets than most of the others, it holds the key to the Continent's economic outlook.
The first quarter GDP figures for Germany were higher than expected, showing signs that even better growth could be on its way. Consumer confidence remains high thanks to lower interest rates and real growth in wages. With these positive factors in place, consumption should continue to be the main driver of the economy for the rest of this year. With business confidence also improving and capacity utilisation already high, investment should increase.
But the biggest potential economic boost should come from exports, hit hardest last year by the Russian and Asian crises. This was the largest contributor to the slide in the German economy, but with Asia on the mend and the world economy looking better than was expected at the start of 1999, Germany's larger dependence on exported goods should benefit from the upward swing.
While the headline-hitting, rocky debut of the euro may be overstated - considering the strength of its component currencies in the second half of last year - a weaker currency can only make Germany's exports more competitive. The weak euro's negative impact on sentiment is also misplaced considering the pain caused to UK exporters by the strength of sterling.
We therefore believe that there is potential for German GDP growth to surprise on the upside due to higher exports to international markets. We are already overweight the German market due to our confidence in their economy, particularly at the consumer level.
We had also increased positions in German consumer stocks at the end of the first quarter. This was rewarded by the stocks outperforming as improving trends in general spending, company results and forward looking statements became apparent.
Given our increasing confidence that there is potential for an improvement in exports, we have been looking at stocks that are likely to benefit from increased export activity in areas such as engineering and chemicals.
In the rest of Europe, we are attracted to the oil sector, not only due to the increase in consolidation amongst the majors, but also due to the belief that the oil price is well underpinned by the low level of inventories and is likely to rise further because of increased demand later in the year.
In general we are underweight commodity cyclicals elsewhere due to their lower pricing power and failure to hold on to cost improvements. We remain overweight in domestic cyclicals throughout Europe and are looking to increase weightings further in capital good stocks.
We are also hoping to increase positions in the banking sector when the bond markets are more stable, as this sector should benefit from the improvement in loan growth from an expanding economy.
We have been underweight in the financial sector due to our perception that the impact of improved growth expectations would be negative for bond markets, and hence the sector.
Ian McNeil is investment manager, European equities at Norwich Union Investment Management
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