Head still above water
How strong is the recovery in the Euro-zone economy? Not strong enough, according to Pedro Solbes, European Commissioner of Economic and Monetary Affairs. Presenting the EC’s spring forecast last month, he warned that that although prospects for the world economy were more favourable than foreseen in the autumn forecast of last year, “we have to acknowledge the hard truth that the EU economy is not participating fully in the positive global economic performance.”
The European Central Bank (ECB) is now expected cut interest rates sooner rather than later. Austria Creditanstalt in Vienna, for example, expects a rate cut before the summer.
Monika Rosen, head of research in asset management at Bank Austria Creditanstalt, says : “The data suggest that the recovery in Euroland is turning out to be much weaker than in the US. That’s why the recent correction in the bond market has been much more pronounced in the US than in Euroland.”
The strength of the euro is not to blame, she says. “Exports have suffered from a stronger euro but since the dollar has turned round in February we are now seeing quite a bit of relief on that front. But exports have never been the problem The problem is domestic consumption and that’s what the ECB are trying to encourage with the idea of possibly considering a rate cut to get people spending again.”
Some of the main drivers of the Euro-zone equity markets last year and early this year – mergers & acquisitions and corporate restructuring – may have slowed down, Rosen says. What is driving the market currently is corporate results: “The market is very focused on company results and company outlooks. Nokia’s revenue warning led to quite a bit of selling.”
Yet there have been generally few nasty surprises. “So far the reporting season has been predominantly positive. Intel and Nokia have been disappointments, but results have been mostly above expectations. Companies have learned not to surprise the market at the last moment, but to give a profits warning if one needs to be issued.”
Something the equity market has also been watching closely more recently is the behaviour of bond market, Rosen says. “With the bond market backing up the way it has done in recent days that has in turn worried the equity market. I think the equity market is now aware of the fact that rates and long term yields will not very easily head lower than they have already done. So we can at best maintain present levels or back up.”
Investors are uncertain which direction to turn, whether this from bonds to equities or cyclicals to defensives. The cyclical rally of 2003 may be over for the moment, says Rosen. “ The market is no longer so sure footed. In 2003 it was all about expectations being very low and very easy to top, and that’s what drove the market. That is no longer the case. Expectations are higher and are priced into the stock prices.”
The result has been a sector rotation with cyclical stocks – particularly technology – losing ground to defensives. The three worst performing European equity sectors are currently technology, basic resources and financials – all sectors that prospered last year.
Yet some Euro-zone investment managers feel that cyclicals, on balance, still represent the best bet in Euro-zone equity markets. Fraser Chalmers, head of European equities at Standard Life Investments (SLI) in Edinburgh says global growth will buoy up cyclicals: “Our house view still has a cyclical bias, given our expectation for global GDP growth, and we maintain a materially light position within defensive sectors,” he says.
SLI is currently overweight in technology and financials, and underweight in the food and beverage sectors. These are sectors that tend to underperform in markets that are being driven by the expansionary phase of the economic cycle.
But will the expansionary phase of the cycle be enough to lift the Euro-zone? The state of the European equity markets is encouraging. Most markets are currently in the black for the year. The DAX is up 1.5%, the CAC is up more than 5%, Switzerland is up 5.5% and Stockholm is up 12%. Not spectacular, but not at all bad.