European stock markets responded positively to strong earnings results and an upturn in eurozone act...
European stock markets responded positively to strong earnings results and an upturn in eurozone activity in December and January. Fourth quarter 2004 real GDP in the UK was revised up to 3.2% (quarter on quarter, annualised) representing the 50th consecutive quarter of expansion.
Weakness in retail sales data failed to stem nervousness of an imminent rate hike, as wages rose 4.3% year-on-year in the final quarter of 2004, well above the 1.6% rise in consumer prices. Corporate news included the LSE seeing off a hostile £1.3bn bid from Deutsche Borse, excellent 2004 earnings growth from the high street banks (prompting criticism in the press over 'excess profits'), and BAe buying the US defence company UDI, for $4.1bn in cash.
Dividend increases and share buy-back programmes were a feature of 2004 profits announcements, contributing greatly to investor sentiment, and helping the FTSE 100 index to break through the 4,900 and then 5,000 barriers during February.
Continental Europe outperformed the UK, helped by stronger-than-expected economic data at the start of the quarter (particularly in Germany), which suggested that the period of weakness over the second half of 2004 was coming to an end. Fourth quarter and 2004 earnings growth was impressive, thanks to cost cutting rather than top line revenue growth but this, in turn, contributed to further increases in unemployment.
The precarious state of eurozone regional growth was highlighted in March, when indicators weakened once again. The eurozone PMI index slipped slightly, retail sales data came in worse than expected in Germany and Italy, and there was a fall in the German Ifo confidence survey. Corporate news included Deutsche Bank announcing a worldwide re-structuring plan that involves cutting 6,400 staff, and Novartis paying $8.3bn in cash for privately owned Hexal of Germany. The French and Italian governments put on hold certain tax cuts due to budget constraints, while at the same time they, along with Germany, led a successful attempt to significantly water down the Growth and Stability Pact that had been used to try to limit eurozone budget deficits.
In the eurozone, restructuring will continue to be a strong theme, but until domestic demand improves there will be doubts over the likelihood of a self-sustaining recovery taking hold. The problem is that reductions in labour costs have a direct and negative impact on consumer confidence. However, the long-term effect of restructuring - assuming that eurozone governments change policies to make it attractive for companies to re-invest their profits - will be beneficial.
The UK stock market benefits from a strong underlying economy, attractive valuations relative to gilts, and - in the short term at least - its exposure to oil and mining stocks. But perhaps of greater importance is the strong message of confidence that has come from companies in their recent earnings announcements by announcing higher dividends (+16% in aggregate), and share buy-backs. Investors have demonstrated a marked preference for companies that return cash, rather than engage in M&A activity.
In the eurozone, restructuring will continue to be a strong theme and the driving force behind profits growth. The outlook for top line sales growth, however, is limited in the near term since the cost cutting associated with restructuring is contributing to rising unemployment and is negatively impacting on consumer confidence.
UK equities remain very attractive against bonds, backed by the strongest of all our signal readings. Valuation, business cycle, liquidity and technical drivers have influenced these signals, all of which are very supportive. Economic data during the first quarter has generally been disappointing. Retail sales activity has been weak, as has housing market data, but in addition manufacturing and services sector PMIs have been declining. The Bank of England may thus stay its hand and not tighten interest rates. The market - not to mention the MPC - is increasingly split as to the direction of the next move in rates.
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