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Expat Investor : September 2007
expatinvestor.com 24 EXPAT INVESTOR September 2007 FIRST PERSON To some market commentators the positive performance of European equities over the last three years has been surprising. Calvin Vaudin, Investment Manager, of Ashburton's European Equity Fund, explains what's going on and what investors can expect. Since early 2004, the European equity indices have outperformed their US and many Far East counterparts in local currency terms, despite poorer macro outlooks. As can be seen in chart 1, GDP growth has been considerably lower than most areas and has certainly not been a place that offered booming economies, full employment, and strong consumers. However, the performance seen in European equities has not been led by domestically orientated stocks, but by the exporters (see chart 2). It has very much been a stock pickers' market, where a clear understanding of which sectors and individual companies could benefit from global growth was essential. There has been little point investing in a company that relied on domestic consumers and struggled to control their costs, the most expensive being wages. The insatiable demand for everything from raw materials to luxury goods from the fast-growing economies, in particular China and India, has driven profits for the exporters. These companies have also been very successful in reducing their wage costs by moving their production to Eastern Europe or, in some cases, moving the production directly to the area of sales. Importantly now, however,whilst global growth still remains at a high level, European GDP has begun to strengthen (see chart 1). This is expected to continue with GDP forecasts for 2007 now standing at 2.7%. Naturally, this is the important foundation for a recovery in the domestically orientated sectors of the equity markets. If we take Germany, the heartland of industrial Europe, as a proxy, the following events are beginning to and, are expected to, continue to unfold. Firstly, due to the poor economic environment, there was little consumer spending, as people were more concerned about the high unemployment and security of their own jobs. This has led to a German savings ratio of 10% versus the UK's 5% and the free spending US, a nation of debtors, with a ratio of --1.5%. However, as unemployment continues to fall, as expected, so the propensity to save falls and the consumer spends more (see chart 3). Secondly, since 1995 the construction sector declined by over 40% (see chart 4) as the economy remained weak. However, it appears to have bottomed as the feel-good factor has slowly returned. Indeed, the federal government themselves are keen to improve the infrastructure which has suffered from the more austere times. They are encouraging Public Private Partnerships and have earmarked 9bn for next year, but as a fall of 1 million in unemployment represents a 20 billion reduction in social security spending, much more could well become available. Thirdly, the importance of getting a country back to work is clearly illustrated in chart 5, which emphasises the close correlation between German employment expectations and the two main indices -- the DAX and the MDAX. Fr ench governments, both left and right, have tried to ignite momentum through structural reform union-led street protests. However, the landslide victory of Sarkozy in the recent elections is seen as a clear mandate for change. The new government plans to move fast, with some new draft laws already in progress. One of these obliges unions to start negotiations over the guarantee of minimum service on public transport, even during strikes. This will stop the economy literally grinding to a halt. Other measures to stimulate and maintain economic growth include a 11bn fiscal package, aimed at cutting taxes on labour and companies, to encourage job-creation and discourage outsourcing and, to persuade the French to spend more time at work and less on welfare. To encourage longer working hours they plan to exonerate, from social charges and income tax, all time worked over the 35-hour week. A number of popular tax breaks are also being introduced which include a cap on personal income tax, a new tax break on mortgage- interest payments and cuts in inheritance tax. Naturally, even with a strong majority, this will not be easy to achieve, as financing the above will involve reducing the civil-service headcount and introducing small charges for health care. But, if achieved, the net fiscal stimulus could well be an additional 0.3% in the Fr ench GDP for 2008. In summary, Europe remains an exciting place to invest. With global growth still relatively strong, the European based exporters remain attractive. More importantly however, Europe itself is fast becoming a region for investment as GDP grows, unemployment falls, consumer confidence returns and the major governments appear not only anxious to maintain this path but also to be in a position to do so. To find out more from Ashburton, enquire through the fast facts number below. The stories driving European equity markets Fast Facts 77490 Chart 4 Chart 5 Chart 3 Source: Bloomberg Source: Bloomberg Source: Haver Chart 1 Chart 2 Source: Bloomberg
July August 2007