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Weathering the storm

After a period of relative stability, analysts are reporting renewed caution and uncertainty in Europe’s markets, brought on initially by the threat of terrorist attacks and war, and now by the WorldCom affair.
“Quite frankly this is another accounting scandal that we could do without,” says Catherine Reilly, an economist at Conventum Securities in Helsinki. She says selling in the markets is still panic driven and this latest crisis will only bring volatility back to the markets.
“The markets are still not being driven by fundamentals, which would indicate real stability, and the general feeling is that you just can’t trust anyone. Enron was bad enough, and the markets were just about over that,” she comments.
Reilly stresses, however, that scandals such as Enron and WorldCom have immediate and short-term impacts on the markets and that analysts shouldn’t lose sight of the longer-term phenomena, such as the euro-dollar exchange rate and interest rates.
“The immediate outcome of the affair will see investors demanding higher risk premiums coupled with lower P/E ratios. Investor awareness will undoubtedly also rise as they won’t want to be caught out,” Reilly says.
Dominic Sanasi, senior asset manager at Bank Degroof in Brussels, says it is early days to assess the full damage the scandal will cause Europe’s equity markets, bit it is further confirmation that the bubble was about to burst.
“This a basically a reality check. The bubble created by both market analysts and consultants has well and truly burst. The good old days of 1998, 1999 and early 2000 were based on nothing. The WorldCom scandal is a frank reminder of that,” he comments.
Sanasi says the fact that it was a telecoms company doesn’t help. “Telecoms companies across Europe have already taken a bit of a battering and are in for another one now. This is a good lesson for the future.”
Sanasi says WorldCom could lead to a change in the way investors do their business, moving away from the traditional earnings and profit predictions and looking instead at solid indicators such as dividends. “Investors in Europe’s markets are now beginning to wonder whom they can trust. They are now just as distrustful of analysts as companies themselves. They want to put their money where the money is. That means we will probably see investors putting their money in companies that can fully honour their dividend payments.”
Sanasi says logic will take over, as it doesn’t add up if a company reports high earnings and profits but then fails or has difficulty paying dividends.
“Who can blame investors for being cautious when companies are lending and paying their chief executives vast amounts of money when their profits are down. We won’t achieve real stability until we start looking at fundamentals again, as that’s where the money is,” he says, echoing Reilly.
Analysts at Merrill Lynch Investment Managers (MLIM) in London say that Europe’s equity markets were dragged down once again in the past couple of weeks by US equity markets with technology and telecoms being the main culprits. They claim hardware and equipment manufacturer stocks within these sectors fell by almost 20% in euro terms and the collapse of alternative telecoms carrier, KPN Quest and WorldCom added to the market misery.
But they weren’t the only sectors to suffer. MLIM points out that Europe’s pharmaceutical stocks also fell by 8% last month.
In fact, according to MLIM, only two sectors in Euroland posted positive stock market performances: automobiles (+2%) and materials (+1%).
At Deutsche Bank in Frankfurt, researchers believe the Euro-zone’s equity markets are not far from their lowest levels recorded last September. “Trouble in the Middle East, the Kashmir dispute and now WorldCom have created panic again just when we thought the markets would turnaround. The inflationary threat was receding and economic data coming out of both Germany and the US was improving. It was all too good to be true,” a spokesman there says.
However, Deutsche Bank points out that the depressed state of the markets means equities in Europe are now looking relatively cheap compared to bonds. “There had been a trend towards bonds but the falls in the equity markets mean that longer term, investors will be attracted back to equities. It is a matter of weathering the storm. Problem is, it’s quite a big storm and it’s lingering,” says its spokesman.
Elsewhere, the recent good performance of the euro attracted a mixed bag of criticism.
“We mustn’t lose sight that it’s essentially a market based on a weak dollar, not a strong euro. And a bad dollar spells trouble for Europe’s equity markets,” says Sanasi, adding that this is another factor behind the current market volatility and caution. “The reality is Europe is still driven by the US. A weak dollar and its ramifications will be felt here as much as over there, regardless of the euro’s position.”
Reilly agrees that it is more a question of the dollar falling, not the euro rising, but the stability of the common currency is having a positive effect. “The fact that the euro isn’t falling and is holding up against a depreciated dollar should help Europe’s export markets and attract inward investment. I believe the dollar was over-valued anyway so the current exchange rate is fair. Europe at least stands to benefit,” she says.
Reilly also believes the stability of the euro eases the pressure on the ECB to increase interest rates and helps dampen inflation, another recent menace.

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