The recent spate of optimism in Euroland’s equity markets is beginning to wane as inflationary fears keep resurfacing.
“I have very little confidence in the equity markets at the moment. It’s not that the markets are doing badly, but they have become somewhat stagnant. Until the ECB increases rates and deals more effectively with inflation, I shall be sticking with my prognosis to invest in bonds,” says Andrea Albertini, a Euro-zone portfolio manager at Sara Assicurazioni in Rome.
Albertini says his current portfolio only has an equity weighting of 2%, and although he traditionally deals more in fixed income anyway, this is not the asset split he would like to see. “I would like to invest more in equities but the markets need the impetus of interest rate hikes of between 50 and 75 basis points to get going again and hold inflation at bay. That isn’t going to happen yet. Unfortunately, I don’t foresee any real changes until the end of the year.”
If he were going to buy equities, Albertini says he would plum for basic cyclicals, tech, telecoms and utilities. He says as the yield curve begins to come down, he anticipates these sectors will take off. “We have been waiting quite a long-time in Europe for stocks in these sectors to turn around. I firmly believe they will by the end of the year when the markets confirm that the recent good P/E ratios are fair.”
Marc Breutsch at Swiss Life in Zurich says the ECB’s target of 2% inflation for 2002 is unrealistic and the recent wage settlements, particularly in Germany, are not helping the recovery. “In Germany the settlements almost reached the 4% mark, which would have meant the ECB would definitely have failed. The problem is they were high enough to spell trouble when combined with other factors, such as weak consumer confidence and lack of private capital coming into the Euro-zone.” He believes the ECB needs to act soon but appears confused over what action to take. “As usual,” he comments.
However, on the business and institutional front, Breutsch confirms that the recovery this side of the Atlantic is going smoothly and beginning to outpace the US. “Institutional investors are definitely putting more cash into European equities at the moment, as capital flows into Europe are much greater. Clearly the distrust of investing in the US caused by Enron is helping the markets here. They are wondering what exactly they are buying over there but feel pretty safe investing in Europe instead.”
Furthermore, Breutsch also questions the macroeconomic data coming out of the US which he suggests is somewhat overly optimistic. “The Americans keep issuing GDP figures that quite frankly are completely out of touch with economic reality. I don’t know whom they are kidding, but again it’s the Europeans that are benefiting,” he comments.
Breutsch believes that GDP expectations in Euroland are fair and if its stock markets continue to trade at very high discounts, the recovery should continue. “Euro area stocks are trading at such high discounts that they are obviously not over-valued and this will attract more inward investment.”
Nonetheless, Breutsch still feels that the year overall will fall below the market consensus for Euroland as stated at the beginning of 2002, even if the second quarter will post better quarterly figures than expected. “Weak private demand and consumer confidence caused by inflation and high energy costs coupled with a lack of recovery in the labour markets will see to that,” he says.
Researchers at BNP Paribas in Paris say that poor productivity levels and the aggregate demand-supply pressures are the main culprits keeping inflation high.
BNP Paribas believes that the ECB’s interest rate policy was too slack during the last upswing and that the role of the exchange rate is overplayed. It claims investors that have been investing quite heavily in Euroland recently will be driven away again if inflation continues to grow.
Though BNP Paribas expects core inflation to start drifting down soon as improved productivity in the Euro-zone outweighs the adverse affects from tightening labour and consumer markets, the long-term prospects look serious when you consider the impact of wage negotiations. “We have major concerns about the effects wage bargaining will have on the markets in Euroland. The recovery so far this year has been smooth and justified. And Europe is doing better than the States, which is an achievement in itself. I hope wage demands don’t ignite inflation and bring us down again,” says a spokesman.
BNP Paribas says that blaming the euro for inflation is a mistake and criticises the ECB’s lack of action to curb it. “Yes the stock markets across Europe are performing well but the ECB needs to get its act together. It the_recovery won’t last if the ECB doesn’t act soon,” the spokesman there says.
According to BNP Paribas, the euro, though still undervalued, is stable and is not a destabilising factor in attracting greater inward investment into the Euroland, but monetary policy is and it accuses the ECB of ignoring money. “But if money grows ‘too fast’, causing inflation to go up, people won’t want to part with so much of it for the same product. The ECB needs to increase rates soon, and independently of the Fed if need be.”

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