After a rebound across the board in the second half of 2003, the first quarter of 2004 saw a correct...
After a rebound across the board in the second half of 2003, the first quarter of 2004 saw a correction in markets as investors re-assessed their positions. This happened partly as a result of events in Spain, but also because of overstretched valuations. Lower quality, highly-geared companies will not now be pulled along by a momentum of ever-rising markets. There will, instead, be a focus on quality.
The terrorist attack in Madrid has two prospective consequences for European markets. First, uncertainty has returned as investors speculate on the possibility of future attacks in other European cities. The risk premium on equities has risen as a result of this uncertainty. Secondly, investors must live with the new political development that terrorist groups are perhaps now able to influence the outcome of a national election.
Overall, however, there is reason to be cautiously optimistic on the outlook for European markets for the remainder of 2004. Despite its recent appreciation, the dollar will probably continue to adversely affect European companies. An interest rate cut from the ECB is increasingly likely, which should boost European equities.
With signs of consumer sluggishness and low growth rates across Europe, it is expected defensive, non-cyclical sectors - breweries, for instance - to be strong in the short to medium term. A company such as Heineken may perform well going forward. A 'one-product company', it has one of the highest quality brands in Europe. Although its share price may be hit in the short term because of dollar exposure, it has great management and its reputation among consumers should make it a good long-term growth story.
Small and mid-caps continue to look attractive relative to large caps. Despite strong performance throughout 2003, smaller companies are still attractively valued relative to large caps and are, on average, trading at a 10%-15% discount. They tend also to have less dollar exposure. Perhaps most significantly, increased M&A activity should lead to a situation where small and mid caps become targets for acquisitive large caps.
One company that could be a favourite in small-cap stocks is Groupe Partouche, a French gaming company with operations across Europe and in northern Africa. The company has performed well recently, its share price lifted by news of a positive regulatory outcome from the French government allowing it to put more slot machines into its casinos. Sector consolidation has also highlighted the discounted valuation of the company, which we feel will continue to perform well for some time yet.
Investors should also turn their attention to some of Europe's smaller markets which are enjoying the strongest economic growth and which are less affected by global geopolitical risk. An investment approach which is focused on sound valuation principles will highlight several quality companies which have done, and should continue to do, well regardless of how broader markets perform.
There has also been some analysis of eastern Europe for some time and two good growth opportunities have been identified in Hungary: Danubius and FHB Landcredit. Danubius is a hotel company with a strong presence across eastern Europe, while FHB Landcredit is a state-guaranteed mortgage company which should benefit substantially from an increase in private ownership in Hungary.
With continuing concerns about the strength of the euro against the US dollar and the slow pace of recovery in domestic activity in some of Europe's larger economies, investors are likely to become increasingly discerning. As a result, the gap between the performance of companies which can deliver earnings growth above expectations, and those which cannot, will widen.
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