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All eyes on Iraq

Europe’s equity markets have entered a period of paralysis in the past few weeks, say analysts, as all eyes are now firmly turned towards the US and its threatened military action against Iraq. There is a general consensus that Europe may suffer more since it imports more oil than the US and the equity markets here are reacting less favourably to fiscal and monetary stimulus, which will ultimately weaken domestic consumer demand and keep the markets down.
“More unwelcome developments that could adversely affect Euroland’s equity markets,” says Monika Rosen, head of research at Bank Austria in Vienna. “The problem is that with no real positive data or economic and political developments to boost the markets, there is nothing for traders or investors alike to latch onto.”
Rosen believes the troubles still stem from last year’s terrorist attack in New York. “We have just passed the first anniversary of the September 11 attacks and it is the psychological effect of these more than anything else that now drive the markets,” she claims.
Nonetheless she identifies a double bottom in the markets in Europe which is generally indicative of an upward swing. “This is relatively good news but we have to put it in context. There is still an overall downward trend to which we see no immediate end.”
Rosen says some sectors have returned to the black during September, traditionally an uncertain month for equity markets. “September is the month when large-scale profits and earnings forecasts are published. Right now these are expected to be pretty flat if not negative.”
Media stocks are up, as are the financial services, retail, basic resources and construction sectors. But tech stocks, cyclicals and insurance stocks are down. Rosen says the long-term picture remains pessimistic.
“There really isn’t anything to write home about. Despite gains and several sectors showing positive trading levels for September, the index is actually down 30% since the beginning of the year and the year-on-year view reveals that not one single sector is trading in the black. They are all reporting negative positions over the longer-term perspective,” she says.
Analysts at ABN Amro in Amsterdam say the main area of concern for Europe’s markets has switched from the accounting scandals of recent months to the US/Iraq stand-off. “Europe’s weaknesses are once again exposed as everything now depends on what the US decides to do. Not to mention the destabilising effect that military action could have on oil prices,” says a spokesman there.
However, ABN Amro believes the effects of rising oil prices will be very short-term. “Rising oil prices will cause inflationary pressure but the effects of changes to energy stocks won’t last long. And let’s not forget that in the initial period following the Gulf war, there was actually a rally in the equity markets, so we might not need to worry that much.”
The feeling at ABN Amro is that providing any military action is short-lived, Europe’s depressed equity markets should manage to come out relatively unscathed. “There is enough oil to go round at the moment so as long as the conflict doesn’t escalate to a long-term and drawn out campaign, we should get off lightly,” the spokesman explains, adding that the Europe’s airline and insurance sectors reacted positively to the news that Iraq would comply with weapons inspections despite the obvious impact a war would have on these stocks.
Rosen agrees that the Iraq affair highlights Euroland’s dependence on US equity markets. “There are other geo-political developments, such as the forthcoming German elections, going on here in Europe that would normally have an influence on the equity markets here, but they are being somewhat overshadowed by US market reaction to the Iraqi problem.”
Rosen confirms that rising oil prices would affect inflation, something else that Euroland could do without. “Inflation was already causing a bit of a stir at the beginning of the year now it looks like it’s back to haunt us at the end of the year,” she says.
At Schroder Salomon Smith Barney (SSMB) in London the feeling is that recession is unlikely in Europe despite modest growth and the equity markets here generally lacking momentum.
SSMB agrees that oil price hikes as a result of imminent military action in the Gulf will push headline inflation moderately higher in the Euro-zone as well as add pressure to already depressed corporate margins, but the longer term perspective will see it quickly come down again and remain low, helping the markets rally towards recovery next year.
Moreover, possible interest cuts in normal trading conditions soon will help the markets pull themselves out the doldrums, says SSMB, though given the current situation in the Gulf, they are likely to remain unchanged for the coming weeks.
Looking beyond the extraordinary events that have kept Europe’s equity markets down, SSMB points out the problems of domestic consumer demand, particular in Germany, where it has collapsed altogether and now stands at a weaker point than during the post-reunification recession in 1993. Though other major countries are not experiencing such a dramatic slowdown, the German decline has a profound impact on Euroland’s export markets and domestic orders.
However, foreign demand and inward investment into the Euro-zone from overseas players may soon get a boost as the euro begins to weaken against the dollar. “It was good to see the euro rally earlier this year but in all honesty a weaker euro pays dividends in the export markets in Europe, which are crucial to the recovery we seek in the equity markets here,” says Rosen.

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