Into the second month of trading in the euro, institutional investors within Euroland continue to stick close to the safer option of large cap stocks, and this trend looks set to dominate the market in the medium term. Overall, the dominant mood of Euroland equities markets still reflects the bull phase that they have been enjoying since October. The fact that investors are staying with large caps is beginning to have an impact, particularly in the smaller national markets, such as the Irish. There the top 10 stocks are up 7% year to date, against 5% growth for the rest of the market. The large are getting larger, and the smaller are suffering as a result," says Joe Burnell of JE Davy Stockbrokers in Dublin. "There is not a lot of interest in small to mid cap stocks , and this situation is not unique to Ireland."
This is due to a combination of factors. Because Ireland is within Euroland, European institutional investors are paying more attention to the market there, and the larger stocks simply have a higher profile throughout Europe. In addition, Irish institutional investors are taking more notice of investment opportunities outside Ireland. Recent M&A activity has reflected this trading pattern. The high profile mergers to hit the market have all been domestic, rather than cross-border, points out Gareth Evans, European equities strategist at ING Baring in London. As examples, he cites the consolidation in the Italian banking sector as well as the French SocGen-Paribas deal. Companies are manoeuvring to grow larger in their own countries, trying to gain a broader national presence, and then they will begin to look for cross-border opportunities. In Evans' view, the M&A theme will continue in the long term, driving markets higher across Euroland.
Although not much has changed regarding investor preference for large cap stocks, Hugo Lasat, managing director of Cordius Asset Management in Brussels, sees a measure of confusion in the markets. In his view, because there is no consensus on the definitions of what makes a large, mid or small cap, there are opportunities out there for index providers or asset managers to fill the gap. Until there is an agreed definition, it is not possible to make accurate comparisons of the various products on the market for institutional in-vestors.
Lasat sees "a revolution" in the next two to three years, as markets grow and become increasingly integrated.
"Since mid-1998, our dom-estic market has been the Euro-zone, not Belgium," he says. "Those investors who want to stay country-based will have some strategic problems." Trading focus has to change from being based on national markets to being based on sectors and market capitalisation. He points out that Cordius launched 32 new products in the last 12 months, and only one was a country fund. "The same developments will take place in Euroland as has in the US. There will be increasing segmentation based on investment styles and market capitalisation," he says. This will create op-portunities for asset managers and consultants who serve those institutional investors that need to change their focus.
The US is also making its influence felt in the markets in other ways, injecting a new risk to the overall buoyant atmosphere. "There has been a dramatic change in expectations regarding economic growth in the US," points out ING Baring's Evans. Growth looks to be stronger than expected, and US bond yields have climbed. If European bond yields follow that pattern, it may cause a trading shift. "In Europe the valuation of equities relative to bonds has been a reason to invest in equities, even though the P/E values are high," Evans explains. Although there is not fundamental reasons to expect that European bond yields will rise significantly, European markets frequently reflect what is happening in the US. The fall in value of the euro since its inception at the beginning of January - it is down more than 5% against the dollar - has had some effect on trading patterns. "The weaker euro is part of the reason that we are seeing a shift from growth stocks into cyclicals," says Evans, since the weaker euro makes cyclicals appear stronger. None-theless, Evans is still recommending sticking with growth stocks, such as tele-comms and pharmaceuticals, warning that overall economic conditions are still in a slowdown, and that corporate results statements do not signal any real recovery.
Whether or not the weakness of the euro will slow the projected fall in interest rates remains to be seen.
The ECB is expected to lower interest rates by 50 basis points by the end of the second quarter of this year, and lower interest rates across Euroland will be a positive influence on the markets."