Time for Europe's turnaround
What a remarkably unpredictable year 2000 was for the world’s stock markets. Fearful of the impact of rising oil prices, the bursting of the tech bubble, the weak Euro, slowing growth and increasingly volatile markets, investor confidence has taken a severe beating in recent months. Earnings disappointments further rocked markets in the last quarter, sending technology shares tumbling. But the Nasdaq decline has merely returned the index to its summer 1999 level from which it began its record five month run. Yes global growth does appear to be slowing, but was this not what central banks were trying to achieve with their interest rate hikes?
Though, the days of the ‘goldilocks’ economy are well and truly over for the US, there has been little evidence as yet to suggest a recession is lurking in the shadows. Growth is undoubtedly slowing. This moderation of growth in itself is not such a bad thing. Whilst a recession looks unlikely right now, the US economy faces more risk in 2001 than it has done for several years.
Concern has grown in recent months, over the sustainability of the unprecedented strength of productivity growth in the US over the past 10 years. If, as many believe productivity gains have been largely down to the one-off effect of the integration of new technologies, it is highly unlikely that productivity growth and subsequently economic performance will be as strong over the next decade as they have been in the past 10 years. Weaker than consensus profits growth will doubtless continue to threaten stability of US equity markets. More worryingly for the long term, the US is harbouring a huge current account deficit - any sudden reversal of capital flows would place further negative pressure on economic activity and prompt a weakening of the dollar. To add to the list of woes, the Fed is unlikely to consider weakening the monetary screws until inflationary fears subside, despite evidence of slowing growth. We can thus expect US markets to remain volatile until the Federal Reserve cuts rates, which it will probably do around spring.
The economic outlook for Europe is looking rather more favourable than recent performance of the euro might suggest. Whilst growth rates in the Euro-zone look set to moderate in the coming months, there is a very strong case for European economies outperforming the US in the coming year. Industrial confidence levels are at higher levels in Europe than in the US and unemployment rates are on a steady downward trend. With deregulation, liberalisation and new technology providing powerful deflationary pressure in the Euro-zone and the annual ex-energy inflation rate at 1 – 1.5 % below the level in the US, we shouldn’t be seeing any further interest rate hikes from the ECB.
In contrast to the US, Europe has a current account which is broadly in balance. European companies themselves are becoming more competitive, more productive and ultimately more profitable as a direct result of continued restructuring efforts and global consolidation. Tax reform legislation throughout Europe will almost certainly be the catalyst for further reorganisation in 2001. Add to this the benefits reaped from improved exports on the back of a weak euro. If Europe continues to grow at a superior rate to the US, the euro should begin to regain some ground which will be very good news for European equities.
Whilst in recent months Japan’s economic recovery appeared to be faring well, the recent decline of various economic indicators has become a major concern. Both the EPA Leading Index and the OECD Leading Index have begun to soften in recent months which could signal slowing growth in the months to come. Although industrial production and capital expenditure remain sturdy, household spending is weak and consumer prices continue to fall. Despite some progress, structural reform efforts have been nowhere near the scale and pace needed to ensure any enduring recovery. With the strong pace of public spending growth in decline and acutely low interest rates, a weakening of the yen sometime soon looks highly probable.
Prospects for emerging economies will certainly look all the more encouraging if the US manages to steer clear of a hard landing. Any potential interest rate cuts by the Fed, would also be very good news for the developing world.
Though we remain on our guard until the global picture becomes clearer, we do see a very strong long-term case for investing in emerging markets.
With uncertainty prevailing in global equity markets in recent months we have preferred to err on the side of caution. The near term prognosis is looking better. 1, growth and corporate profits are weakening, but with inflation low and interest rate hikes at an end for now, the markets should be able to recover some lost ground. Bonds should perform satisfactorily in coming months, although an expected revival in global equity markets will take some gloss off.
Michael Collins is a senior investment manager at Pictet Asset Management in London.