Why a buyer's market
If anyone had any doubts that the Euro-zone is currently a buyers’ market for equity investors, the flotation of Postbank dispelled them.
The initial public offering (IPO) of Postbank, the financial service arm of Deutsche Post, was the biggest initial public offering for four years. Yet to ensure the flotation succeeded, Deutsche Post was forced to reduce the number of shares on offer and cut the price range of the shares.
Dominique Dequidt, head of French midcap products at BNP Paribas Asset Management (BNP PAM) comments: “European investors are currently very cautious about price so Deutsche Post needed to lower the price in order to interest them. We are seeing the same thing with the IPOs of French companies. At the moment, we are more in a buyers’ market than a sellers’ market.”
Is investors’ caution justified? Economic indicators are broadly encouraging. The European manufacturing and service PMI indices, both reliable barometers of Euro-zone business confidence, rose in May confirming the acceleration of the European economy.
Business confidence is underpinned by employment growth and hence consumer spending. Consumer spending rose 0.6% in the first quarter of 2004, its strongest increase since the first quarter of 2001.
Market indicators are also encouraging, Dequidt says: “Equity valuations seem quite low to us. If we see earnings growth in Europe it could be very interesting for an equity manager, because the consensus on equity growth is about 12% in 2004. It could be more in 2005 if recovery takes place in Europe.”
Interest rates also appear to pose no threat, he says. “Interest rates are quite low and have stayed low for quite a long time. Even though the long term rate has risen a little since the beginning of the year this has not been hard on the market.
European currency fluctuations – the euro against the dollar and the yen – have also steadied. “We see that the trend is quite flat and could stay flat if the recovery improves.”
Overall, the picture is positive, he says: “There is positive impact from valuation, positive impact from inflows and positive impact from the dividend policy of companies. Many companies have restructured their balance sheet and now have huge cash flow. This means they could improve the dividend policy through dividends and share buy backs. These are all good things for the market...”
Yet the market has some major worries. “The first fear is about a rise in the interest rates. The second fear is about the oil price. There are also fears that inflation is in the pipeline. That could mean that long term interest rates could go up.”
The impact of the oil shock is also an imponderable. “It’s very difficult to say what the effect will be because the markets need more time to digest the effect of the oil increases. We could see more inflation, but that is quite good for companies since it could improve prices and generate more activity.
“Generally we are optimistic for the next three or six months because investors are quite cautious. However there is one small problem that could become a large problem. Inflows are not very high into the equity market. If we want a good increase in the European equity market we need higher inflows into the portfolio.”
The momentum of recovery in the uro-zone will benefit cyclical stocks in the second half of the year, Dequidt expects. “During the flat market since the beginning of the year we had an expansion of P/Es price/earnings_ratios for defensive stocks and no expansion for cyclical,
“But we have seen some large consolidations of cyclicals such as construction in the last three months, so we could see an expansion of cyclical P/Es next month. We could have a cyclicals recovery in stock prices during the second half of the year with more momentum in the European recovery and always momentum in the US and in Asia.”
The segment of the market that will expand fastest, Dequidt suggests, are the B2B (business to business) companies, which will use their cash flows to become more competitive or improve earnings. “We have seen large cash flows from these companies we think there could be more capex capital_expenditure in the next two years.”