Market views - EUROPE

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EUROPE

June 2010

Economic Background

The global banking crisis and subsequent recession has now given way to renewed growth and greater confidence in governments to stabilize the financial system. But the price of this support for the financial system has been a ballooning in public debt and for some countries the debt burden is proving unsustainable. Many have described this as a second phase in the credit crisis. Sovereign debt is now a major headache. Certainly the phase of super stimulus has ended. Interest rates in Europe may not yet be on the rise, but government spending is being pared back. The implications for economic growth in this phase is negative and now the big question posed is can the fragile recovery remain in place, while governments slash spending plans to reduce debt? For some the problems are very real and if this spills over into more economies there is increased risk of a further downturn in economic activity.

The economic background in Europe remains more challenging than other regions. Asia and to a lesser extent, the USA have emerged from recession with vigour, but European growth rates remain low and several countries such as Greece and Spain appear trapped in a phase of weak or negative growth. These countries face specific problems. Greece has high public debt and has had to seek emergency support from the European Union and IMF after struggling to convince international investors to continue to fund further debt issuance. Spain, in contrast has a very depressed property sector which has paralysed the domestic banking sector and forced the government to introduce tough measurers to halt the burgeoning public sector debt levels. In sharp contrast, countries such as Germany, Sweden and Norway continue to prosper and are benefiting from the strong growth in other export markets. This has been further supported by the weakness of the Euro, which has given a much needed boost to sectors such as the car manufacturers, chemical producers and industrials. Given the much greater size of the German economy, compared to Spain, the net effect is that the European economy is emerging from recession, but there are clear winners and losers in the current economic environment.

The Stock Market

The European debt crisis has provided an excuse for the market to rotate away from companies benefiting from the recovery and back into companies with solid long term growth prospects, that had been left behind in the sharp market rally. Likewise, we have seen a big sell off in Greek, Spanish and Italian companies and strong returns in Germany, Sweden and Denmark.

Outlook

Significant cuts were made to our investments in Spain, Greece, Portugal and Italy and profits were taken in mid cap stocks which had had great performance until May 2010. The number of stocks has been reduced and our exposure to broad economic recovery has been scaled back. The overall balance of the fund is now more towards medium and long term growth rather than short term cyclical recovery. Economic growth in the region remains well below that of other areas and while governments remain focused on cutting spending, the prospects for further improvements in the economy remain limited. Whilst the valuation of the market compares well with other markets it is not compelling and prospects for the Euro remain negative.

Page last updated July, 2010 ID1720