As predicted in June trading in equities across Euroland has been pretty flat over the summer, and with results predicted to be in line with expectations, more of the same is anticipated as we approach the final quarter.
Sharon Coombs, joint head of European equity analysis at HSBC, says that Euroland is likely to slow down over the last quarter in the face of weakening growth, reflecting the position in the US. “We would expect the Fed to raise rates by 25 basis points just before the November election, and perhaps once more before the year end. In Euroland rate hikes are also anticipated as the signs of inflation are in place. This would lead to a slow down in growth as those hikes kick in.”
She warns, however, that the ECB may react with a full half point rate increase, and that this would be a cause for concern. Earlier in the year the bank has responded to inflation fears, caused mainly by the rise in oil prices over which it has little control, and most analysts are hoping for a more measured approach over the next six months.
Nigel Cobby, managing director of research marketing at Deutsche, takes a more pessimistic view of the ECB’s likely policy. “Although the major change over the summer has been the realisation that a major increase in interest rates in the US is no longer necessary, that is not the case in Europe. Continuing growth in productivity has taken the pressure off the Fed, and only oil prices seem to be affecting inflation projections.” He agrees with Coombs that a small increase is likely next month, but feels that may be all until the year end. “The story in Europe is very different, however, and we would not be surprised to see a full 1% increase over the next six months. The problem is the continuing weakness of the Euro, but we are not sure that the ECB has the policy right, or that hiking rates will necessarily make the problem go away. “
Against this background Coombs suggests investors should avoid cyclicals and move to more defensive stocks, and financials. “We will probably continue to avoid media and telecoms stocks, and look more towards IT hardware and software companies,” she said, warning that some margin pressure was evident in chemicals, as oil price levels began to kick in.
The problems of oil prices was also raised by Plum Shipton, joint head of European equity research at Merrill Lynch. “It should not be assumed that oil prices will come back down,” she warned. “We may well now be in a new band of prices, which will mean no return to the days of $20 a barrel or less. Indeed, the price may well continue to rise for some time yet.” Some analysts have even suggested that it could spike up to $50, albeit to fall back again. Nevertheless, with some inflation projections being prepared with the oil price stripped out, on the basis that it is artificially high, there is substantial room for error.
Although the weakness of the euro has meant that some sectors have benefited, and reflected this in their results, Coombs warns that these should not be used as a basis for projections of next year’s earnings.
Pointing out that worldwide outlook for equities is healthy, Cobby is still concerned about Europe. “We may be overly pessimistic, but that is probably the best position to begin from,” he says. “Nevertheless, the inflow of cash to funds in Europe should be seen as a long-term reality. Pension reform across the continent, the continuing popularity of the equity culture and deregulation should all mean that we see a cash-rich market.” He warns, however, that this is just as well. “The market will need a high level of demand over the next six months as we anticipate a flood of IPOs, so we are looking at a very active market over the next two quarters.”
Even so, he feels people will not be looking at economically sensitive stock for a while yet. “I would expect defensive stocks, with pharmaceuticals and food sectors performing well. By the end of the year, however, we should see a move back to telecoms, particularly the larger players who have suffered a little of late in the wake of the new licence auctions.”
Shipton agrees that cash levels are rising, as investors wait for economic conditions to return to equity-friendly levels. “We are still not seeing those conditions,” she says. “And even when we do there is a lot of supply coming to the market in the next quarter, so expect a busy market.”
At the moment, however, she believes that the jury is still out on whether or not we can expect a soft landing for the economy in the US, with the usual consequences for Euroland. She agrees with a figure of 50 basis points for ECB rate hikes until the year end, but like Cobby fears that may not be enough. “Consequently I would prefer financials, and bond-sensitive stocksat the moment,” she says.