After last month’s dramatic correction, and the prospect of, finally, a slowing down in the US economy, equity markets look to be in for the kind of period of fiscal tightening which they abhor.
Joe Hall, euro equity analyst at Deutsche in London says: “A lot of money has come out of technology but also media and particularly telecoms. The hardest hit have been the ISP companies, the start ups, especially in Spain and Italy. In Germany the Neuer Markt has also taken a battering, in particular the smaller listed companies.”
He sees some rotation into food companies, and pharmaceuticals: “The latter still remain down in absolute terms over the past month, and are certainly underpriced. Both have shown stable earnings, but have not done particularly well over the past 18 months, and so look cheap and attractive now,” says Hall. Turning to other sectors he points out some good news from the energy sector: “The oil companies have fared relatively well, and some of them are actually up in absolute terms, but I suppose the ones that have done best are the utilities.”
While financials have seen some recovery, faced with a sharp rise in interest rates following the April inflation indicators in the US, there is likely to be dwindling enthusiasm for the sector according to Hall. The question remains, however, just how bad can the equity slump can get: “To a certain extent, a lot of the shake out has happened and a lot of stocks have lost close to 50%. If you want to be gloomy, however, in the last two major corrections in 1987 and 1998 the central banks had the option of injecting liquidity, but that is not going to happen this time. What we are going to see is more tightening, and markets don’t like tightening. So I would say we have had a good part of the fall, but we are in for a protracted bear market which has started as an attack but could last a long time.”
Certainly all indications are that it will last as long as it takes to slow the economies down, which could be anything from six to nine months. So far as the central banks are concerned, the Fed probably has one more hike before it even considers lowering rates as it has done in previous crises, and will probably want to see US GDP at a more sustainable 2.5-3% before it acts.
Even so, earnings across Europe should perform well over the next two quarters, and the engine economies are basically sound. The question is not ‘if’ a consolidation period will come, but ‘when’. Hillary Cook at Barclays Stockbrokers says: “The correction of equities against bonds and new technology against traditional stocks is overdue, and it is almost a relief that it has arrived. With interest rates going up there was a need for an equity adjustment.There are some bargains out there, but the problem is lack of liquidity. Investors will be forced to sell before they can move in on the attractive sectors.”
Meanwhile Philip Wolstencroft joint head of European Equity Research at Merrill Lynch feels that the bear market may well be short lived: “Although there may be some correlation between the US and Europe, we believe that there is a time lag which will come into operation. The economic cycles are clearly out of synch, and although Europe may have to look at a three month bear market, that is probably as long as it will take to disconnect from the US. You can make an argument that pan-Europe is over priced by 20% and the US by 40% before we get back to cheap levels. Europe is less expensive than America; its economy is less exposed to the stock market and its business cycle is in an up trend rather than a downtrend. Those are the three main differences.”
Clearly, inflation-free expansion is what everyone is looking for, and Europe seems to be offering that whereas the US economy suggests there are worries. So where do interest rates hikes enter the equation? Wolstencroft says: “Generally speaking our guess is that central banks around the world have 50 basis points that will probably be going on in the next few months, I certainly would not be looking for any rate cuts. In previous dips stock markets were very cheap, that is not the case now. Central banks cut interest rates then, they will not now.”

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