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The wheel comes full circle

The Euro-zone equity markets in the first half of January have been the complete opposite of December. This is the view of Ad van Tiggelen of ING Investment Management in The Hague. “December was basically flat index-wise, whilst recently there has been a trend reversal, with people selling off positions in an erstwhile strong TNT sector.” Defensives, such as pharmaceuticals and food, are profiting from this turnabout.
He says the shift in confidence was brought on by poor economic data from the US. “There are increasing fears about a hard landing in the US.” Profit warnings and negative balance sheets of telecoms companies have also had an influence.
Ludo Geris of KBC Asset Management in Brussels also says that there has been instability in recent weeks. “The markets remain quite volatile, with a steep recovery in the telecoms sector and defensives doing well. All in all there is no clear trend to report.”
Harald Schmidlin of Commerz Asset Managers in Frankfurt feels that ‘window dressing’ – where investors look at their portfolios and size them up on the basis of structure and not performance – by large US institutions has not been favourable to European and technology stocks and this is affecting the markets. “US investors are selling their European stocks and therefore Europe is beginning to lose out.”
The sudden interest rate cut in the US in early January will not cause too many problems in Euroland, says Geris. “There will be some kind of fallout, particularly for companies that have important interests in the US, but in general the macro-economic effect on Euro-zone will be limited.” He also believes that there will be positive effects from the rate cut. “Not only will we see the potential for lower inflation but also cheaper imports.” The European Central Bank (ECB) will also be in a stronger position to cut rates than might have otherwise been the case.
Schmidlin thinks that the recent cut in the US will only have an impact in Euroland if the euro were to weaken, because this would put the ECB under pressure to cut rates more quickly. “The Euroland economy is not in such bad shape as the US, and is not slowing down so fast as a result of consumer tax incentives and stronger performances by the euro,” he says. He doesn’t foresee the ECB cutting rates until the middle of 2001, and certainly not during the first quarter.
Van Tiggelen points to the timing of the US cut as the decisive factor shaping its consequences. “The 50 basis points cut is not a surprise in itself, but the timing was. We expected it at the end of the month, not the beginning. And for the first time in ages, it came during market hours.” This allowed people to get out of short positions very quickly, particularly technology stocks, which were held in large numbers by hedge funds. “We saw the Nasdaq go from –2% to +12% in a matter of minutes.” He believes that this has led to a change in market sentiment. “We are now seeing another sector rotation,” he says. “People are selling defensives and buying cyclicals and TMT again.”
Hence Deutsche Telekom is up 22%, whilst KPN and Portugal Telecom are both up 30%. This is evidence that that Euroland tends to mirror developments in the US. “The sector rotation is just as visible here as in the US. The telecoms sector here has out-performed pharmaceuticals and food by as much as 25%. This is maybe a bit too dramatic.”
Van Tiggelen doesn’t believe that slight downward variations in growth and earnings in 2001 across Euroland are worrisome. “Growth will fall back from 3% to 2.5% and earnings from 20% to somewhere between 5–10%. But there is no panic at all in Europe, in fact I would warn against too much euphoria.” Whereas people now expected the US rate cut to produce a soft landing, in Europe “there won’t be any kind of landing whatsoever.”
Whilst cuts by the ECB are anticipated, they won’t come as fast, because growth is not decelerating so much in Euro-zone. “Economic data in France and the Netherlands are good, whilst in Germany things are OK, despite being somewhat patchy,” says van Tiggelen.

The main barrier to dollar/euro parity continues to be the growth differential between countries, says Schmidlin. “This is still coming down in Europe’s favour, and the effect is further strengthened by the stability of consumer demand here and the link between currency movements and export demand.” Even though the value of the euro has gone up, it still remains low enough to help exports. Parity, expected this year, will benefit Euroland stock markets but profits will be affected if it were to rise too sharply too quickly.
Geris believes that the recent pause in the euro’s recovery is temporary. “The current recovery is fully justified and has a lot further to go yet.” He also sees parity this year but warns of the potentially negative impact of a strong euro. “In countries where companies operate in very competitive environment alongside US stocks, things could become more difficult than they would have been six or seven months ago.” But he also believes that the euro remains on the “cheap side” and Euroland markets will benefit.

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