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Still looking for the bottom

The eyes of market players in Europe, and especially Germany, remain firmly fixed on developments in the US. It was noteworthy that there were differing reactions to the profit warning from software producer Oracle. While the price of SAP fell on the news, Siemens, Epcos and Infineon were able to hold their ground. We regard this as an encouraging sign that investment decisions are once again being gradually based on the quality of companies’ fundamentals. Nonetheless, uncertainty on the future trend of the US economy, and with it the US stock markets, is likely to ensure that volatility on European equity markets will remain high for the time being.
The search for the bottom is apparently not over. In this regard, purchasers generally should not be in any rush. Nevertheless, we also recommend – in view of the overall rather negative market sentiment – moving into successive anticyclical new commitments in selected blue chips.
The European Central Bank is still showing no discernable intention to relax monetary policy in the immediate future. We expect the ECB to wait a while, so as to be in a better position to assess how the economies of the US and Japan will develop and what the resultant implication for European growth will be. Inflation is not developing in a way that should impede a rate cut.
February’s German consumer prices did rise more than expected (by 0.6% month-on-month) in contrast to January, even on the basis of a harmonised EMU consumer price index. But the pressure from upstream prices is clearly abating on balance. We still believe that November’s European inflation rate of 2.9% year-on-year will be the highest for the foreseeable future, even if it takes its time to get back down to the 2% level. The declining growth in M3 money supply is no longer an obstacle to relaxing monetary policy. But overall we believe there are few signs that the ECB will decide on a dramatic cut in base rates. The money market yield curve inversion should start reverting in about six months’ time. The data should confirm that growth is cooling off, but that order books and production continue to look good. Given this scenario, we continue to expect yields at the long end to remain below 5% for the moment. A change in sentiment could bring about higher yields, but there is currently no sign of this.
On publication of the US consumer confidence figures, bonds of all maturities recorded notable gains. The yield on 10-year Treasuries fell noticeably below the 5% level for the first time since January. The shift of capital away from the equity markets and the buyback of long maturity government bonds both had a positive effect.
Given the large price increases, we believe that further increases are only possible if the US economic recession deepens – taking on a U-shaped trajectory. We believe that the fair value for 10-year Treasuries should be just above 5% at the moment. We therefore recommend selling at the long end.
Recent Euro-zone data confirm the expected dip in growth. German GDP grew much more slowly in the fourth quarter of 2000 than in the previous quarter – by 1.9% year-on-year against 2.8% – as a result of the lack of impetus from consumption and net exports. Industrial sentiment was again pessimistic in February as a consequence. Both the European Commission’s industrial confidence indicator (down from 3 to 1) and the Reuters purchasing managers’ index dropped once again. Overall, the leading indicators suggest that EMU economic growth will slow to around 2.8% in the first three months of this year before accelerating again in the summer.
The US economy is continuing to weaken, albeit at a slower pace than in recent months. We believe that the latest data make the prospect of a V-shaped economic trajectory (where the economy bounces back to higher levels of growth following a brief, marked pause in growth) less likely. It remains equally unclear whether there will be a U-shaped trajectory (ie, a recession) or a trend somewhere between a U and V, which would largely correspond to our economic predictions. High consumer spending and a swift recovery in IT investment will be necessary if the economy is to recover significantly. It may well be that the current high level of IT resources in US companies will not mean a total collapse in demand for investment, given the relatively rapid rate at which IT products become obsolete and need to be replaced.
However, this is far outweighed by the risk that consumer demand will remain depressed. A combination of asset values being wiped out by price drops in Nasdaq technology stocks and rising energy costs looks likely to continue severely damaging private consumption. Even the tax cuts announced by the Bush administration are unlikely to prevent the decline, having instead just a moderate effect on weak demand.
Peter Worel is first vice president, investment analyst at Bayerische Landesbank in Munich

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