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Political climate prompts caution prompts caution

Euroland analysts are taking a cautious approach to equities, uncertain of the way forward for both Germany and the US, the west’s two biggest economies. In-creasing political uncertainty in the EC is also taking its toll.
The continuing decline in the value of the euro against the dollar has been one trend effecting the outlook on equities. This is clearly allied to the unexpected strength in the US economy – as long as the US economy continues to show strength, then the euro will continue to show weakness relative to the dollar. However, it is also linked to concerns about Germany’s economy, which has been in the doldrums recently. Another factor contributing to the weakness of the euro is undoubtedly market uncertainty following the mass resignations at the EC.
The weakness of the euro has dominated equities trading in the Euro-zone countries, according to Alex Ions, equities strategist at Dresdner Kleinwort Benson in London. “It has boosted tradable goods stocks, many of which are cyclical stocks, while more defensive, more domestic, equities have under-performed.”
Low Euroland interest rates are another key economic factor effecting the equities outlook. As long as interest rates remain low, then valuation rates on Euroland equities will be sustainable.
Although it is likely that the European Central Bank will want to maintain Euro-zone interest rates at their current level, again, whether or not interest rates rise is in some ways dependent on decisions made in Washington DC.
“The US sets the trends,” says Astrid Smit, investment strategist at ABN-Amro, in Amsterdam. “The US economy is balanced on the edge, and in our view it is not totally clear which direction the economy will take.” However, despite its current strength, she does expect some decline in the US economy over the medium term, a view shared by many other observers.
Most analysts are generally pessimistic about growth forecasts for the Euroland economies, predicting lower growth for both Euroland and the UK in the short to medium term.
This translates into moderate returns in the equities markets: Smit is predicting moderate EPS growth forecasts, in the single digits or maybe 10%, as well as returns of between 5 to 10% on equities over the coming 12 months.
However, according to Thierry Lacraz, European equities analyst at Pictet et Cie in Geneva, “Pictet is more positive and optimistic regarding growth prospects” than many of its competitors. “For the time being the feeling is that recovery is relatively difficult, and people are gloomy about growth prospects. But this is not the case when you look at the figures.”
In Lacraz’s view, Euroland is currently balanced between two different attitudes: European consumers are generally buoyant, although industry is in a negative mood. It may be that the surprise resignation of German finance minister Oskar Lafontaine will be the trigger to a more positive attitude among European industry.
“Sometimes you don’t need a big event to change the big picture,” says Lacraz. “This might be the small spark needed to ignite the German market,” particularly if Lafontaine’s replacement, Hans Eichel, is more business-friendly.
Although, as he stresses: “Euroland is not Germany,” Germany’s economic influence is far-reaching, and a more positive attitude among German industry will spread throughout Euro-land.
Smit is more cautious. “One man is not enough to change the whole policy, but government policy might become more pragmatic.”
In this uncertain economic environment, analysts are taking different positions toward sector recommendations. Consumer goods stocks are attracting a great deal of interest, because of high levels of consumer confidence – both ABN Amro and Pictet are very positive on these. As Lacraz says: “The market is seeing a change of leadership. After 18 months of focusing on defensive growth stocks, we are now looking at more economically sensitive stocks, such as the car industry and consumer goods.”
However, despite the recent strength in cyclical, tradable stocks, most analysts are cautiously recommending that investors avoid them. Their greater exposure to the US economy will mean that they will suffer once the expected downturn occurs. The large cap stocks favoured by most institutional investors are also very dependent on the US dollar, Smit pointed out.
The financial sector is seeing continued interest. “The financial sector could continue to see some strength from consolidation,” says Ions. This is linked to a positive view of southern European markets. “The strength in peripheral, southern European markets will continue as they retain a greater degree of buoyancy than the core Euroland countries,” he says.
“As it happens, the southern European equities markets have a greater domination by financial sector stocks.”

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