It never rains, but it pours, the British government must have thought recently. A rash of closures and job losses across the UK in recent weeks has been blamed on the high value of sterling, and the manufacturing sector has been the scene of stories of doom and gloom. But what of the other side of the coin, or indeed the other coinage – the Euro and its impact on manufacturing in Euroland?
As in most sectors the main worry is whether interest rates have peaked, and just how strong the Euro’s recovery will be. A sharp spike could mean problems for industry in Euroland, where many companies price their materials in dollars, but a recovering economy and slow growth could offset that.
A number of fund managers, with the most money to invest, are looking at manufacturing. The valuations which we are seeing reflect a fairly distressed level of pricing power, which clearly is not the case. There is plenty of stock out there which is undervalued, and fund managers with huge funds to invest cannot afford to sit on it in such circumstances, so is there cause for optimism?
Stefan Bergheim economist with Merrill Lynch in Frankfurt says: “Short term over the next few months the manufacturing sector should look very good. We have seen strong order inflow, and very positive market sentiment readings in Euroland. Mid-term could be even better, but towards the end of the year we will see the impact of global rate hikes on the global economy and therefore on demand for European manufacturing products.”
On interest rates, Bergheim believes they have already peaked, both in the US and in Euroland. “All the indicators suggest the aims of the recent hikes have been achieved, and that should mean the ECB has done for now.”
He also anticipates a moderate strengthening of the Euro. Euroland, moreover, is expected to slow down last and least of the three major regions. “At the moment we are seeing some countries outperform and some underperform, but the direction across Europe is the same for everyone, especially in manufacturing,” says Bergheim. “The extent of the slowdown may differ slightly in Spain or France, where domestic demand is very strong compared with Germany. Also countries which export most of their manufactured goods will behave differently from others which have high domestic consumption.”
Nick Wilson at ING Barings in London feels that the sector can represent an opportunity if we return to a stock-picking market. “Loathe as I am to use the phrase, there is no doubt that there are great opportunities in what is a relatively small sector. If we look at Euroland we are really concentrating on Germany as the driving force, and there are a number of companies whose future earnings are not necessarily reflected in their price.” He points out also that the companies which are developing and mixing old and new commerce are the most attractive. “There is of course the old heavy engineering and steel production part of the sector, but there are also companies producing semi-conductors and concentrating on B2B aspects of their business.”
We will see different results in these sub-sectors, but it is not so easy to separate them. Wilson believes that investors should look for companies which are producing good cash figures and have a traditional market share.
“Even if we see a rise of another 2% in interest rates, these companies will still be around and performing because of their market share,” he says.
Nevertheless, he suspects that we have seen a peak in interest rates, agreeing with Bergheim. “It does seem as if we have topped out, but this is one sector which is particularly vulnerable to speculation about rates. The value of the euro is also a major factor, but interestingly if we do see a recovery in the euro it may be that stocks outside of Euroland, in Britain and Scandinavia may benefit. The reason for this is that the latter have survived a difficult period and those that are still in the market will benefit for having priced in these difficulties.
Good news, then, for this particular sector, and perhaps an Indian Summer in prospect later in the year if interest rates have peaked, and Euroland sees a gentle deflation.