The Enron affair appears to be the main culprit preventing Euroland from landing on its feet.
“Euro-zone’s equity markets would definitely have gone up if Enron hadn’t created a new wave of panic,” says Gilles Meshaka, head of European equity management at CDC IXIS Asset Management in Paris. He believes accounting and balance sheet problems are leading investors to lose faith in stocks they might have invested in.
“The markets here have been gripped by fear somewhat in the last couple of weeks. And the Enron scandal has opened a can of worms that has spread to Europe,” he adds, pointing out that problems at Cable & Wireless and France Telecom were also causing damage. “Cable & Wireless in Europe has been reporting things as revenue which isn’t strictly speaking revenue and France Telecom has been putting put options in companies that are obliged to buy them back at a pretty high price. It’s such a shame because on the general economic front, things were beginning to improve.”
Meshaka says that this is leading investors to begin questioning earnings, even though Euro-zone market valuations over bond yields made the equity markets look very attractive. “Investors are asking themselves if they can believe what companies are claiming to be accurate earnings. Things were looking up on both sides of the Atlantic. It seems that every time things start going well, something else comes along that knocks us off our perch.”
Sarah Drakes, a European equity strategist at Merrill Lynch in London, agrees that the main trend in Europe’s equity markets recently has been concern over accounting standards. “This is a problem that has been thrown up by the Enron debacle and is without doubt preventing the markets from rising.”
She says that managers were now looking for a return to quality but only European managers were looking to Euroland for refuge from the US. “There has been a sharp decline in the last couple of weeks in managers opting for the US as the market with the best quality stocks. But unfortunately, whilst many Europeans are looking in their own backyard for value, overseas investors are plumping for emerging markets. ”
Drakes feels that this is somewhat odd, given that European stocks are probably undervalued at the moment whereas the rest of the world was considered fair value. “It’s a little puzzling. European stocks are definitely cheaper comparatively than elsewhere right now, but many appear to be holding out.
One reason Drakes suggests that investors are not turning to Euroland is that the Enron affair has left them somewhat distrustful and they are waiting to see what other repercussions there could be. “There is a quality issue in the US versus a valuation issue in the Euro-zone. Theoretically that should mean good news for Euroland. But many managers, having raised their cash positions, appear to be waiting to see what happens next in the Enron saga. Or maybe they’re playing the wait-and-see game, hoping the European markets go even lower, in which case equities here would be even more attractive,” she comments.
Nevertheless, she expects the European markets to continue trading in the same flat trading line for the next few weeks. “Despite good data and specific stocks doing really well, if you look at various euro-zone indices over the last couple of months, you can draw a straight line through them. And I don’t anticipate seeing that change just yet.”
Analysts at Commerzbank in Frankfurt believe that ‘Enronitis’ is simply the beginning of a balance sheet scrutineering exercise that will reveal “mistakes and crimes all over the place” that are the result of the 1990s investment boom. “European markets are now playing catch-up. We have to be careful that the highly contagious spread of Enron-itis doesn’t have too damaging an effect on the slight upward trend we were seeing in the markets a couple of weeks back,” says a spokesman there.
He adds that the markets will probably survive though as the 11 September attack had had a profound effect on the way the markets respond to crises. “There was an effective market crash in Europe the week after the attack, but this helped condition the markets to expect the worst. So, hopefully, Enron, the AIB scandal and the Elan problem will be dealt with as just another facet of the 1990s investment bubble bursting.”
The analysts agree that there is still room for another interest rate cut in Europe. “Another cut in Europe would be the icing on the cake really, since, Enron aside, there is no real reason now why the markets here don’t pick up. Still a little more stimulus is always welcome,” says Drakes. She believes that the markets have already priced in the fact that the Fed is unlikely to cut again, but the ECB has room for one more in the coming weeks.
Moreover, she believes that people might finally be warming to the ECB’s restrictive policy. “The ECB came in for a lot of flack last year for not responding quickly enough, but it did act appropriately and Euroland’s economy is ready to turn around. I think the markets are finally acknowledging that now.”
Meshake believes that long-term rates may rise by the end of the year and that this could be positive for Euroland, as further cuts could prove counter-productive.