The physical introduction of the euro this month, when households, businesses and retail banks will start using and trading in euro-denominated bank notes and coins, is likely to have a positive effect on Europe’s equity markets, analysts agree
“Though it is difficult to say what kind of impact the changeover will have on the stock markets, the logical assumption is that, though we are not going to see any real difference – since most institutions and businesses have been using the euro for the last two years anyway – markets are likely to react well,” says Dominic Sanasi, senior asset manager at Bank Degroof in Brussels.
He believes that we could see the start of a trend towards managers opting for large cap stocks in the equity markets and even European companies taking business away from their UK counterparts. “I think there will be a movement towards large caps in the equity markets, as buying a stock in a common currency becomes a physical reality and Europeans are likely to win market share from the British, since their isolationist monetary stance and high interest rates favour Euroland,” he comments.
Marc Breutsch, head of economic research at Swiss Life Asset Management in Zurich, says the introduction of euro coins and banknotes will help stimulate the equity markets, as it will lead to an appreciation of the euro’s value. “There will be a fundamental base for a stronger euro once the coins and notes have been successfully introduced,” he suggests. However, he notes that it may take time for the impact to be felt, since Europe’s currencies have gained very little against the dollar in recent weeks, despite the US being officially in recession. Investors seem to be delaying buying the new currency until the successful changeover becomes evident in the markets.
“Nonetheless, during 2002 we believe that all European currencies will gain against the dollar, stimulating the markets,” he adds.
Analysts at Commerzbank in Frankfurt say that, although the introduction of the euro will have little effect on macroeconomics, there are some concerns that inflation will rise as a result of the “psychological rounding-up”, meaning investors and retailers alike will convert at a convenient rate rather than the actual rate, driving inflation up and damaging investor confidence in the equity markets. But, overall, Commerzbank agrees that the transition is likely to be smooth.
Elsewhere, the highs and optimism shown last month, particularly in the tech, IT and related sectors, are withering.
“The recent rebound is just a technical rebound, given the absolute lows we’d reached, and though last month was a good month, we find ourselves back in the doldrums somewhat now,” says Sanasi.
He cites the end-of-year factor as another reason for the good market sentiment of a few weeks ago, since markets are generally optimistic as one year ends and another begins. But he warns that we should be careful not to be taken in by conflicting signals. “Take for instance the rebound in semi-conductors, which is paradoxically false and not false. Not false because the end of the cycle has been reached and semi-conductors, IT and tech stocks are traditionally the first to recover, but false, because in the short term, the rebound doesn’t really help the markets out of their current depressed position,” he explains.
Sanasi points out that IT has been helped somewhat by financials recently, but, again, reading between the lines reveals that the banks are only window-dressing by selling off bonds in favour of equities to enhance their results.
Breutsch at Swiss Life believes Euroland’s stock markets are showing signs of stability amidst the talk of worldwide recession and are riding the storm. “The equity markets across the Euro-zone are currently digesting bad news very well and monetary easing by the central banks is not yet over this cycle.”
He says, however, that predictions that earnings in 2002 will outstrip those for 2000 are unrealistic, even if they haven’t been priced into the markets yet.
Nevertheless, Breutsch confirms that Swiss Life remains positive in its outlook for the equity markets in the coming six to 12 months as the first stage of a cyclical recovery is driven by liquidity. At the moment, he claims, there remains a high level of liquidity in the markets induced by central bank rate cuts since the terrorist attacks on New York in September.
But the market volatility caused by the same event means there is a greater element of hope in these predictions than in the past. “If business and consumer confidence are restored in the second half of 2002 thanks to successful military, fiscal and monetary action, investors may be right to expect a recovery in corporate earnings. But this assessment still contains a lot of hope, as the visibility on corporate profits has not improved in any market in recent weeks,” he comments.
Talking of monetary policy sees the ECB once again come in for a rough ride. “The ECB still has room to cut, but once again is stalling. The expected cut at the end of the year didn’t materialise and I find myself once again wondering what’s going on with them the_ECB,” says Sanasi.
Breutsch agrees that the ECB reacts too slowly and now doesn’t expect the anticipated year-end 25 basis point cut until after the successful introduction of euro coins and banknotes.
Sanasi suggests that the ECB’s political agenda to protect against inflation is too stringent. “Euroland could do with another cut to boost its equity markets and thus stimulate higher returns, but the ECB is only concerned with inflation. That is so short-sighted,” he says.