Euro assets under cloud
Inflationary pressures, stagnant interest rates and an ever weakening euro are keeping investors out of Europe, leading to a lack of consumer confidence and keeping the markets across Euroland on an ever downward spiral.
“Inflation in particular is becoming more of a serious issue,” says Harald Sporleder, a European fund manager at Deutsche Investment Trust (DIT) in Frankfurt. He believes that there are two main reason for this. “There is inflationary pressure around in Europe as a result of higher oil prices and the foot and mouth disease.” The recent outbreak of the latter in the UK and subsequently across Europe has forced fresh food prices up and this is now having a knock-on effect.
Noel O’Halloran, head of equities at KBC Asset Management in Dublin, agrees but says that inflation is a lagging factor in the economic cycle and it is too soon to start looking at it. “Fighting inflation at this time is perhaps not the right thing to do.” Moreover, he believes that the real concern for the ECB comes from wage inflation and there is no real pressure there to speak of.
Hermann Pommberger, a portfolio manager at Elvia insurance in Zurich, believes that the current concern over inflation won’t last. “ Inflation is causing some worries but in the long term it will fall.” In Europe, it depends more or less on oil prices and we are at the beginning of a trend reversal in energy prices, he says. “Cheaper energy prices will have a stabilising effect on inflation and I expect we will back to a rate of between 1% and 2% in a year’s time.”
The fears over high inflation are not leaving any room for the ECB to cut interest rates. “High inflation gives no room for manoeuvre for interest rates and since we expect the Fed to make another cut very shortly, there is a fear that the interest rate gap between Europe and the US will widen,” says Sporleder, suggesting there is usually only a time lag of a couple of weeks between rate cuts in either region, but due to the inflationary pressure the ECB will be forced to hold out even if the US moves soon, despite a continuing downturn in the markets. “I’m not optimistic that there will be a cut here soon, but we will need one in a couple of months to help stimulate the markets.”
O’Halloran would like to see the ECB take a more proactive attitude towards interest rates than of late. “I’d like to see the ECB cutting rates more aggressively, but with inflation way above target that’s unlikely to happen.” He does nonetheless foresee a cut in the not so distant future.
Pommberger believes that as a very conservative institution the ECB won’t act too quickly and that too much importance is placed on interest rates anyway. “Interest rates are not as important as young equity dealers and market makers would have us believe. There are other important issues driving the market, such as falling indices and earnings warnings.” He says that it is interesting to note that the DAX in Germany had lost 25% of its value over the last 12-18 months and that this is a worrying signal that never gets mentioned. He predicts that the US will go down the same road. “We anticipate that the Dow Jones will start coming down. In the long term, I am not too optimistic for the equity markets, and we could see a drop of up t o 20% in the Dow Jones over the next two years.”
The euro continues to be source of perplexity, inspiring conflicting views. Sporleder believes that it is now unrealistic to expect parity and that the negative effects of the weak euro were beginning to outweigh the positive. “To achieve parity, the euro would need to appreciate by 20% and that’s hard to swallow. Whereas a weak currency makes exports cheaper, and that would certainly help Germany, the US economy is struggling so demand for goods is on the wane.” He also thinks that the euro’s continued weakness doesn’t help inflation. “It would be very helpful right now to try and stabilise the single currency to stem inflationary pressure.”
O’Halloran says the euro is unlikely to rally unless the ECB makes three or four rate cuts but that’s not going to happen. “To be honest, I can see it staying pretty flat.” He stresses the correlation that the euro now has with respect to the markets it serves. “The weak euro is basically a manifestation of the lack of confidence outside investors have in all European assets.”
However, Pommberger believes that the euro will go up. “I am optimistic about the euro’s chances, given that the dollar is too highly valued at the moment.” He says that it is possible we will see the euro reach 95% towards parity by the end of the year.
In general, Sporleder finds little rosy to say about the second quarter, quoting low visibility and earnings as the main factors driving the markets ever downwards. “It’s tech and telecoms that continue to do poorly and we now have to face that fact that the more traditional sectors like chemicals and building materials are following suit.” He doesn’t feel that things will get better until the fourth quarter and beyond. “Going forward, I think we need to adopt a nine,12 or even 15 month view.”
The next quarter will see a further deterioration in macro economic forecasts as Euroland slips into an earnings vacuum, says O’Halloran, with Europe continuing to be the worst performing of the major trading blocks. And any recovery will not be home grown. “The US will drive it up or down, Europe won’t drive itself.”