Puzzling over the data
There’s still caution in the markets, despite positive economic data being circulated at the moment.
“We’re basically waiting to see what direction this year is going to take,” says Catherine Reilly, an economist at Conventum Securities in Helsinki. She says that whilst she believes the markets have bottomed out, investors are still waiting for confirmation or refutation that the recovery is underway. “I think that the markets are basically ready to turn the corner, but what will actually happen remains to be seen.”
Ludo Geris, European equities fund manager at KBC Asset Management in Brussels, says that things are quiet to positive at the moment. “There is some evidence that people are confident about economic recovery, but we are also seeing a lot of hesitancy and caution. The threat of disappointment is still quite strong.”
He says that investors are cautious because the macro-economic scenario, particularly in relation to consumer confidence in the US, remains stretched, whist mixed signals are coming out of last quarter 2001 company results. “Some companies posted good results for fourth quarter last year, whilst some posted bad. Some say this is disappointing, whilst others go further and warn that this year won’t actually be any better.”
Teun Draaisma, an analyst at Morgan Stanley Dean Witter in London, says that the recent remarks from Alan Greenspan, chairman of the US Federal Reserve, are adding to the volatile state of the markets. “The markets are reacting to a speech given recently by Greenspan which has led investors to become very cautious. He started off very upbeat in order to win over consumers. Then he completely changed his line, talking about continuing uncertainty and double dips, without the data to support the claims.” Draaisma suggests this has left analysts wondering whether what we are seeing at the moment is a recovery or not. “There is definitely a lot of debate right now about Greenspan’s double dips,” he says.
Draaisma says that the markets have moved sideways and this is somewhat puzzling. “Before Greenspan’s speech, things were getting pretty much back on track, but the markets didn’t really go or up or down. This is quite surprising.”
He believes that the basic factors that will lead to recovery are consumer confidence, and right now everyone is looking to see what happened between Christmas and the New Year, purchasing managers index data and OECD forecasts. “At the moment, everything points to a recovery but the markets remain flat,” he comments.
Reilly agrees that the purchasing managers index and consumer confidence are key to economic recovery. “If these continue to rise then I think we can assume that we are in recovery. Shares have rallied a bit, and are certainly no longer cheap, but this rise in the equity markets is to be expected,” she says.
Sector wise, Reilly says that Conventum is currently recommending early cyclicals but tech stocks come under fire. “We’re still quite cautious and not comfortable with the level of tech valuations. They look pretty expensive and this will be the first sector to fall if the recovery is postponed. The trouble is a substantial recovery in tech stocks has already been priced into the markets without proper confirmation of recovery.” Nonetheless, she doesn’t believe that any sectors have done particularly badly. Telecoms are more or less ok, though not cheap. “We’re more worried about the equipment manufacturers who come under techs,” she adds.
Draaisma also says that cyclicals are doing well but they are underweight in defensives. “This is not a sector to be in when markets and economies are in trouble.” Morgan Stanley is also slightly overweight in TNT, but he is uncomfortable with TNT valuation levels.
Geris says that tech and some cyclicals have done well since the beginning of the year, as the markets were in slightly positive mood, but defensives are lagging somewhat. “On top of that, we are seeing good performances in the utilities and pharmaceutical sectors, especially Glaxo, which had probably dropped a bit too much,” he claims.
The other main point of interest that the analysts discussed was inflation, or rather lack of it. “There is a threat of deflation becoming a problem,” says Draaisma. He says that the current low interest rate scenario coupled with low inflation could lead to trouble later in the year. “We don’t actually think it will happen, but Europe is not immune to the kind of problems we are seeing in Japan at the moment. And we do anticipate inflation in Europe falling below the one per cent mark later this year. Inflation is normally much higher when going into or coming out of recession. It’s a pretty dangerous economic climate and one we’d want to avoid.”
He explains that whilst, paradoxically, in the very short term, deflation may lead to people buying cheaper goods, once they realise that prices will continue to fall, they’ll loose their incentive to buy, meaning catastrophic consequences for equity markets. “People don’t buy goods, so investors don’t invest in companies that aren’t selling, I don’t think I need to say more,” he comments.
Geris agrees that talk of deflation is causing even more concern among traders and investors. “Investors are definitely a little jittery because of deflationary pressure. The US, Europe and Japan are all still trading way below normal levels and the oil prices have stabilised, which is great for inflation, but since the recovery will be minimal, consumers may finally capitulate by the end of the year. This could lead to inflation being too low.”