High Yield Offshore European Investments

On the euro’s first birthday Andrew Album looks to the future of European markets

Continental European bourses disappointed - compared to elsewhere - in 1999. After the euphoria of the successful launch of the euro came the letdown. The attention of international investors drifted eastwards and European companies and politicians were left with the tough task of continuing with the implementation of much needed reforms.

Over the last 12 months, progress has been slower than many had hoped for and this has helped hold share markets back.
Compared to both the performance of other markets and the expectations at the start of the year, this is a disappointment for investors.

High Yield Offshore European Investments - Hangover

“It was a classic case of a hangover from the euphoria in advance of the launch of the euro. Money moved elsewhere, such as Japan, but that trend is now over and we expect to see Europe coming back into favour in 2000,” says Simon Keys, chief equity strategist at Framlingtons.

Gareth Evans, chief European equity strategist at ING Barings, says that the decision by the European Central Bank to increase euro-zone interest rates to 3 per cent clears the way for Continental equities to head upwards over the coming 12 months.

“The problem up until early November was a lot of uncertainty in the market regarding the outlook for interest rates. Bonds have risen sharply in response to the ECB’s move and this makes the relative valuation of equities very positive.”

High Yield Offshore European Investments & Evans

Deutsche Asset Management believes that Europe will do far better in 2000. In a recent report, it declared that “continental European equities remain our favoured asset class among developed markets, with demand both from international investors and domestic retail investors expected to pick up further. GDP growth is forecast to exceed market expectations, which should contribute to stronger corporate earnings growth, and substantial corporate restructuring is expected.”

High Yield Offshore European Investments And Mark Howdle

Strategists at Mercury Asset Management agree that Europe looks good on a medium-term view but are not so sure about the next few months. “The medium-term case in favour of European equities remains, with earnings growth gaining support from restructuring benefits and growing external demand. We expect uncertain short-term performance but are attracted by medium term prospects.”

Several recent actions by German Chancellor Gerhard Schröder served to underline Mercury’s point about the region’s short-term problems. Firstly, he stepped in with cash to rescue construction company Philipp Holzmann from bankruptcy. Then he made overt moves to support engineering to telecoms conglomerate Mannesman when a hostile bid for it was launched by Vodafone Airtouch.

High Yield Offshore European Investments & Germany

Analysts greeted these actions as a clear sign that Germany is still reluctant to allow the market to operate freely and perceive Schröder to be wedded to traditional left-wing concepts such as state intervention.

Gareth Evans agrees that this is a major concern. “High levels of corporate taxation, the slow pace of pension reform, continued inflexibility in labour markets and a reluctance to allow cross border hostile takeovers by governments in Germany and France will continue to deter some international portfolio flows,” he predicts.
Some managers are now focusing on Europe’s smaller markets.

“While the major markets, notably Germany and Italy, are picking up modestly, the eurozone periphery is booming,” says Michael Saunders, analyst at Salomon Smith Barney. Ireland is one example, with its economy growing at a blistering 8 per cent annually.

High Yield Offshore European Investments And Mark Howdle

Mark Howdle, head of European equity strategy at Salomon Smith Barney says that these countries are poised to reap significant benefits from the euro that won’t be realised in the larger markets such as Germany and France. He points out that stronger growth usually leads to higher interest rates, such that what equities gain from having extra earnings growth, they lose from having to apply a higher discount rate to those earnings.

But with the ‘one size fits all’ euro interest-rate policy, a country like Ireland will enjoy higher growth and lower real interest rates than its European partners. This politically-imposed double positive creates the possibility of a free lunch for investors, according to Howdle. Ireland will produce among the highest earnings growth but will have the same discount rate as the continent’ s slowest growing economy. Since there is no currency risk, he thinks that it therefore makes sense to gravitate to those European markets that will benefit from extra earnings.

High Yield Offshore European Investments & Guy Monson Of Sarasin

Monson sees areas such as defence, banking, telecoms, pharmaceuticals and defence as being ripe for further consolidation activity.

The second factor most frequently mentioned is the sheer volume of money that is pouring into European equities. Fortunately, most continental governments have been embarking on large-scale programmes to sell off state-owned assets, and this has helped to avoid a significant short-term supply/demand disequilibrium. But with interest rates at unprecedented levels and most Europeans woefully underprovided for, in terms of pension arrangements, the need to invest in equities will intensify.

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