Playing safe in Europe
The strengthening euro and the poor prospects for Euro-zone growth have combined to create a condition among Euro-zone equity investors which Rick Lacaille, chief investment officer at State Street Global Advisors (SSgA), describes as “Eurogloom”.
“At the start of the year, analysts had generally been too optimistic by an average of 14%. This year, they were infected by the Eurogloom which was swirling around. Many are now downgrading their already modest 2005 earnings outlook, and growth stocks have already suffered,” Lacaille says.
The gloom may be may be overdone, he suggests. Although the recovery of Euro-zone economies remains sluggish, Euro-zone equity markets have outperformed other markets. “The simple explanation is that companies have beaten forecasts. This is very rare.”
Some equity managers are taking a cautiously optimistic view of the Euro-zone market. Susanne Willumsen, senior portfolio manager at SSgA, says: “Despite the renewed strength in the price of crude oil, we believe that solid earnings growth, attractive valuation, favourable technicals, and a generally supportive yield curve continue to support a modestly positive outlook for stocks.
“Although earnings growth is decelerating, third quarter profit expectations continue to be revised higher, which could sustain attractive P/E multiples, given the market’s expectations for only moderate increases in interest rates. Even with the latest rally, breadth indicators support a continuation of the advance and volume has picked up somewhat.”
Willumsen suggests that the market may see a year-end rally in Euro-zone equities, particularly in small caps. “While the period of relative strength in small cap stocks is maturing and the valuation differentials favour larger companies, we remain watchful for a potential year-end rally in stocks, which could ignite another brief period of out-performance in small caps.”
Talk of a year-end rally is too optimistic for some, however. Thomas Biechler Euro-zone equities analyst at Raiffeisen Research in Vienna, says: “We do not support the view that there will be a year-end rally. We have a rather diminishing picture of the market, with decelerating profit growth and the strengthening euro on the horizon. We have already arrived at the year-end highs in the European markets so we do not expect a further rise in equity markets.”
The profits outlook is the main reason for this pessimism, he says.”In the third quarter we quite saw good results but profit outlooks were rather pessimistic and we think that expectations for next year have to come down further.
“We expect as a best case scenario a slightly positive equities performance. Our December target for the DAX is 4100, and this target is within striking distance. We do not expect it to overshoot.”
Biechler is equally pessimistic about prospects for 2005: “In the first half we could see no profit growth or even a fall in profits. We will also see the effects of the high oil prices coming through. Overall, we have lowered our GDP for the Euro-zone.
“Our year-end targets are below the current index levels. The global economic slow-down, with profit margins falling and profit growth decelerating will make it a rather difficult year for Euro-zone equities.” says Biechler.
However, other analysts see brighter prospects for Euro-zone equities in 2005.
Anne Beaudu and Amélie Derambure, economists at Credit Agricole in Paris, observe: “On the equity markets front we are faced with two kinds of risk in 2005, namely moderately higher interest rates and a profits slowdown, while the inflationary rise should remain modest.
“In absolute terms current valuations make any sharp rebound on global equity markets improbable, although the European market retains slightly higher potential for a rebound. In relative terms, however, in comparison
with other asset classes, equity markets should still be able to do well.”