With the continued threat of war in the Middle East hanging over the markets stalling a full-scale recovery, analysts agree that Europe’s equity markets still can’t find real stability, despite some relatively good trading recently and the ECB’s larger than expected 50 basis point interest rate cut. Many predict that market sentiment is about to turn negative again in the coming weeks and that downside potential is definitely on the rise.
Overall, telecoms have shown some recovery, led by both Deustche Telekom and France Telecom restructuring at board level and taking steps to reduce their debts.
Nevertheless, some analysts also believe the good performances of cyclicals and the building and construction industries in Europe highlight long-term investor confidence returning to the markets and that a full recovery may at last be on its way.
“The recent 50 basis point rate cut is not the start of an aggressive easing trend, but a reaction to sluggish growth and continuing downside risks. It makes little difference to overall economic pros-pects,” says Jose Luis Alzola at Schroder Salomon Smith Barney (SSMB) in London. Alzola claims the extra 25 basis points is nothing more than an advance of a cut that would have come by the end of the first quarter this year anyway and says SSMB expects rates to remain at their current low level for most of the year. “Since the recovery remains fragile and downside risks dominate, chances of another cut exceed those of a hike, but this is not the base policy,” he explains.
Overall, however, SSMB says recent economic indicators suggest lees pessimism than before about the economic outlook. “The rate cut comes ironically at a time when several financial indicators create a better outlook,” says Alzola. “Equity indices in Europe have rebounded by some 15% recently and the two-10-year bond yield curve since way back in October suggests investors are lowering the chances of a renewed downturn and the risks of deflation,” he adds.
However, Jean-Pierre Hellebruyck, director of investment strategy at Axa Investment Managers (Axa IM) in Paris, says recent economic indicators imply Europe’s equity markets are still rather flat, with stagnating growth rates, though not in recession. He says Axa IM welcomes the ECB’s 50 basis point cut, which it claimed had a positive impact on the equity markets, but points out that the European Commission still warns the Euroland economy could contract during the first quarter of 2003.
“Recent surveys and economic data would seem to confirm a trend that started last spring: hesitant growth but without recession,” he says, adding this scenario has kept trading flat and not helped uncertainty among traders.
Axa IM believes there are three main factors that could prevent Europe’s equity markets from continuing their slow recovery.
Firstly, it is concerned about the continued lack of investment in the US and a possible weakening of the American consumer market, which has a direct knock-on effect on the consumer markets in Europe. “This is a real threat to the equity markets here, but the least likely to materialise, as the American authorities have taken a very proactive stance to ensure the situation is reversed,” says Hellebruyck.
Secondly, there is the geo-political situation surrounding the Iraqi crisis and its effect on oil prices. Rising oil prices could have far-reaching consequences on inflation. “But we have to say that the price of oil has come back down to around $24 per barrel, and though we think this probably won’t turn into a major problem, the recent worsening of tensions between the US and Iraq means we have to start watching oil price movements more closely again,” he warns.
Finally, Axa IM points to the problems surrounding Germany as the third area for concern. “A threat from inside the Euro-zone. We fear a further collapse of the German economy, particularly given its policy mix which is too restrictive,” says Hellebruyck, who accuses the wider European authorities of reacting too slowly to curb the impact of a weakened Germany on Euroland’s equity markets. “This is a threat that we are taking more seriously but expect the German authorities to take appropriate action in time to avert a further crisis,” he adds.
Over at Bank Degroof in Brussels, analysts agree that the markets in Europe remain perturbed by the geo-political situation in the Middle East and the continued threat of recession but the outlook is more positive over the longer term perspective. “We are still somewhat caught in a period of uncertainty and volatility, with no clear sign which way things are going to go in the immediate future. But we believe nonetheless that long-term investors who don’t follow trends and who keep well-diversified portfolios can act with confidence in Europe,” says a spokesman there.
However, in the short term, Bank Degroof paints a somewhat different picture. It believes the economic situation in Germany, apathy among investors and the lack of government intervention are keeping the markets and the economy firmly on a downward trend. “Overall, we expect the last quarter of 2002 to show a further weakening of the Euroland economy, a trend that will continue at least throughout the first quarter of 2003. The economy here is unlikely to bounce back soon and this won’t restore investor confidence in equities as soon as we’d like,” its spokesman explains.
Though Bank Degroof acknowledges the benefits of lower interest rates, it says interest rates alone won’t lead to a full recovery.
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