There is far too much liquidity in the markets but at long last some positive signs beginning to seep into economic data. This is the view of John Dreyer, head of equities at Fortis Investment Management (FIM) in Paris.
“We are very happy right now. Basically, the bullish stance that we took earlier in the year has been vindicated,” he says. Dreyer believes that the money markets are at a higher point now than when the bull markets started in the early 1980s and this is leading to an unhealthy balance between cash and equity trading levels. “We have charts to suggest that the liquidity levels are at odds with general market conditions.”
Nonetheless he points to the green shoots of recovery as some strategists are beginning to look longer term. “Though most analysts are still advising risk-averse policies in equities trading – and until last week they were right – some strategists, albeit very few, are beginning to raise their exposure to equities again,” he says. He believes that the ripple effect of interest rate cuts will be felt going into next year and this will provide the stimulus for a return to the equity markets.
A spokesperson for Compagnia di San Paolo (Compagnia), a pension fund foundation in Turin, agrees the downturn may finally be coming to an end: “Though we have still not seen the very worst, telecoms followed by tech stocks should show recovery next year.”
He believes that there are good chances telecoms will go up in the second quarter of next year, with tech following in the third and this may stimulate positive sentiment. “Upward movement of prices in these sectors could lead to a major revision in economics forecasts, particularly on the sell side, as analysts are currently using equity growth rates that are too narrow.”
At Schroder Salomon Smith Barney (SSSB) in London, strategists believe that an early, sustained market recovery is unlikely, with no one factor driving it, adding that the market will probably remain nervous and volatile over the coming months.
Whether the US-led military action in Afghanistan in response to the terrorist attacks on New York and Washington in September is having an effect on Europe’s equity markets is open to debate.
“We believe the catalyst for a stock market recovery is more likely to be confidence in a cyclical recovery than further rate cuts or political or military developments,” says SSSB’s strategist. He says that SSSB is nonetheless significantly less bullish now than when a US-led cyclical recovery seemed imminent before the tragedy.
At Compagnia di San Paolo, the feeling is that market analysts believe the military campaign in Afghanistan will be over sooner than anticipated by the Bush administration and this could help the markets recover more quickly. But it is a broad scenario and whilst Europe’s equity market seem more stable at the moment, tighter fiscal policy will be needed to break the mould. “Europe’s markets are definitely more stable now, but the problem is that, when the US economy starts to grow, Europe remains stable. Invariably the US consistently outpaces Europe in times of growth and will do so again,” says Compagnia’s spokesperson, adding that this is the reason investors are not rushing into Europe at the moment.
Dreyer believes that if you look at consumer confidence at the time of the Gulf War in the early 1990s, the curve was actually steeper than the criticism of the then monetary policy might have suggested. “Consumer confidence is always key in determining how equity markets will perform, and although in times of crisis it always dips into recession, it always bounces back soon thereafter.” He suggests, however, that it is too early to say if the current positive steep yield curves will mirror the Gulf War since consumer confidence is a lagging factor.
Contrary to SSSB, both Dreyer and Compagnia’s spokesperson feel that a different fiscal policy would help Europe’s markets and that the ECB would do well to follow the example of the Fed.
“The ECB’s fiscal policy at the moment is doing nothing to help European equity markets, it’s completely opposite to what the Fed is doing,” says Compagnia’s representative, adding that the ECB could be a lot bolder.
Dreyer is even more scathing. “The ECB is a bunch of diplomats and don’t act nearly as aggressively as they ought to. The Fed’s policy is helping the dollar to recover and as such the US continues to lead the cycle, as it always has and always will, regardless of what the Europeans do.”
SSSB says that, although it lowered its estimate of fair value for European equities after the attacks in New York, leaving the European market looking 11% cheaper in terms of risk premiums, it will be 20% higher in a year’s time, as there is no change in bond yields.
Dreyer feels that equity markets will benefit from the liquidity levels being redressed, but this is a difficult issue. “Banks take in more deposits, which leaves them to invest in bonds, making the current situation a great earner for them. But since the assets go into financials before the real economy, inflation can be risk,” he says. However, he feels that inflation is likely to be kept at bay as oil prices haven’t surged and consumer confidence doesn’t appear too damaged at the moment.
Nevertheless, despite a slightly more positive outlook, there is still an air of uncertainty. “These are wild times we’re living in right now, but there are signs that investors in equity markets can start climbing the proverbial wall of worry,” Dreyer comments.

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