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IPE special report May 2018

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Bear limps along

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Economic data is once again the driving force behind the performance of Europe’s equity markets, with analysts playing down the significance and impact of the Iraqi parliament’s unanimous decision not to allow weapons inspectors to return to Iraq.
“It’s not something that we can afford to ignore, but oil prices have only risen a fraction and the key European indices, despite continuing volatility, have not really reacted either to the news,” says Cyril Beuzit, an analyst at BNP Paribas in Paris.
Beuzit says initial falls in Europe’s indices should be seen in context. “The markets always generally react this way to negative news. It is disappointing, as the markets were showing signs of improvement in the last couple of weeks, but the key driver behind the markets is underlying economic data.”
According to Beuzit, weak data expected out of both the US and Germany is keeping Europe’s equity markets down and volatile, and the bear market is looking increasingly uncertain.
“The bear market appears to have run its course. It may not yet be over, since it is still being driven by consolidations as opposed to supporting stocks, but it is looking relatively fragile,” he comments.
Teun Draaisma, an equity strategist at Morgan Stanley in London, claims the bear market is over but it is not being replaced by a bull market in Europe. “We are entering a secular bear market, a period with a wide trading range that could take as much as five years to narrow down again,” he says.
However, Draaisma points out that Euroland’s equity markets are poised for a period of sustained trading. “We mustn’t forget that we are 29% down overall in Europe compared to a year ago, so sustained trading does not imply a return to the highs of a few years back. But there are gains to be made and this is welcome news.”
He believes the upturn in trading is being driven by cheap prices and a turnaround in bond yields. “We think the bond markets have reached their maximum yields. Coupled with the fact that equities are cheap at the moment, this is good news for Europe’s equity markets, as it will lure investors back,” he comments.
Draaisma also believes the Iraqi situation could have a positive effect on equity markets, depending on the length of any military action.
“Morals aside and speaking purely from a business point of view, a quick war would probably benefit the equity markets in Europe as a positive sign that the conflict is over and they can return to their normal business unhindered by extraordinary events.”
Analysts at Robeco in Rotterdam suggest the economic situation in Europe is in better shape than expected as the bear market nears its end and in light of the dismal performance of its equity markets this year. “This is mainly thanks to the fact that consumer spending and confidence has held up relatively well amid the downturn,” says a spokesman there.
Nonetheless, Robeco warns the Iraqi situation could affect this delicate balance and agrees a quick war will bring positive results on the business front. “Europe’s equity markets still lack the strength to rally alone. What happens in Iraq and its impact on the US is now crucial. Consumer confidence in the US will only be affected by a drawn-out military campaign. Given that the American public support military action, a short war will help the equity markets in Europe as the US will be leading the recovery,” says its spokesman.
Overall, Robeco says it is remaining overweight in its European equity portfolios as it expects a recovery in the coming months. “Market valuations are very low in comparison with bond yields and short-term interest rates at the moment and market sentiment has become overly negative. This time of year also favours equities,” the spokesman there comments.
Draaisma believes that the recovery next year will be led by financials, particularly banking and insurance stocks that have shown some growth in recent weeks. “These sectors are relatively cheap and likely to remain at the forefront of any turnaround next year,” he says.
But some analysts feel this is too optimistic. Simone Beer, an independent analyst based in Frankfurt, says when looking at the way banking stocks are doing in the Euro-zone, we need to consider each country separately and break down the stocks by the banking sectors they operate in: “The banking sector in Germany is certainly not doing that well, though that of other Euro-zone countries is. Commerzbank in particular is in trouble and would do well to get out of investment banking to help its overall profitability. Even Deutsche Bank, Germany’s best-performer, will struggle to maintain a good share price as the markets take further hits.”
Beuzit at BNP Paribas believes the main difference at the end of 2002 compared to 2001 is the dominance of risk aversion policies. “We need to encourage investors to take more risk by getting back into equities and out of bonds. Hopefully the expected 50 basis point cut by the ECB this month will trigger the switch,” he says.
Draaisma reckons the ECB cut is probably already priced in and unlikely to have a far-reaching impact, though he doesn’t foresee next year being as bad as this year. “I doubt that 2003 will be as bad as this year, though investors can expect no more than returns of 8–10% next year. Europe’s equity markets next year will certainly remain cautious, if not volatile, and I definitely wouldn’t want to be quoted as saying there will be a return to stability.”

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