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A bad case of pre-millennium tension

History tells us we can expect a slowdown in equity trading as the year nears its end. Last year it was more dramatic than usual thanks to the euro-effect. This year, however, we are likely to see the slowdown turn into a full stop because of Y2K anxiety.
Analysts have been quoted in this column for the past four months warning of pre-millennium tension, but as the date approaches the predictions look like coming true. Add to that other anxieties and it looks as though Christmas may be coming early.
Tomas Teetz, chief equity analyst at Trinkaus in Frankfurt, has a number of concerns. “Although there are worries about Y2K, the market will adjust itself. I would anticipate a busy October, but then volumes will decline. Some institutional investors may even close their books as early as the end of this month,” he says.
Of more concern, however, are recent hikes in interest rates. “I would expect to see them rise again before the year-end,” he warns, “with subsequent effects on equities”.
There are also concerns about the US and the possibility of a fall in the market there. “We could still see the Fed raise interest rates, but the biggest worry is the lack of reserve in the US market, which reflects the variation position in Europe.”
Not everyone shares this concern about interest rates. Juliet Cohn, Euroland equity analyst at Dresdner Global RCM in London, doubts if there will be any great moves in the euro or any change in interest rates before the year-end. But she does share Teetz’ fears about Y2K.
“Last year managers closed down before the launch of the euro. We were told there would be so many problems, and theoretically the euro was a far more expensive exercise than Y2K,” she says.
Looking further ahead, a slow last quarter could well mean we will be able to predict with more accuracy what awaits in the New Year. The first few days of trading after the markets re-opened in January 1999 saw the indices rise by an average 7%. By May this had been given back, and led to a flat summer, supported by the euro’s recovery against the dollar.
Cohn believes the last quarter of this year and the beginning of the first quarter of 2000 could well follow a similar pattern.
There is, however, some good news. Teetz points to company earnings. “We have seen much better p/e ratios than anticipated, and this should help to stabilise the market. We may even be able to foresee some small increases in earnings.”
Cohn also points to some particularly interesting sectors. “We have seen some important adjustments of late. Telecoms, for example, have had high valuations which have been causing some concern, but new entrants are reversing that trend.” IT hardware and software remain, however, popular sub-sectors. “We are certainly overweight in those sectors at the moment, partly because in the past year or so there has been a lot of spending by companies as they upgrade and embrace new technology.”
She also expects the emergence of e-commerce to drive up some company stocks, despite the fact that some fund managers will naturally be nervous about the price/sales ratios, as few of these new companies have shown any profit yet. There are, however, a number of established companies branching out into e-commerce and these are becoming “must-have” stock for fund managers who do not want to miss the boat. Cohn sees security encryption companies as a good example of stock with growth potential.
On the hardware front Nokia remains a success story, and the development of new networks and technological advances in handsets should improve profitability.
“We also like resource companies. Oil in particular is showing a positive theme,” says Cohn.
One more positive theme could be the emergence of cross-border mergers and takeovers as the euro creates a more level playing field. National mergers thought impossible a short while ago, such as Elf–Total, takeovers such as Olivetti and Telecom Italia, could soon be overshadowed by cross-border deals as companies decide that being a national player is no longer enough.
The prospects for a strong performance next year are echoed by Mark Howdle at Salomon Smith Barney. He says that the most important macro indicators for equity investors remain the performance of bond markets and the euro. “We forecast the euro will strengthen against the dollar, and that bond yields will edge slightly higher over the next 12 months.”
He maintains that allowing for the difference in sector mix, Euro-zone equities are trading at 18% p/e discount to US equities, as opposed to an historical mean discount of 5%, unadjusted. This is an indication of Euro-zone cheapness, and lends support to the view that the market will outperform over the next year.

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