The Daily Interview: Mark Cliffe, London-Based Chief Economist for ING Barings

As the U.S. economy has stumbled, some investors are casting their eyes across the Atlantic, where European economies look less vulnerable to a sharp downturn. Meantime, some Europeans who had been throwing their money into U.S. equities in recent years are starting to find their own back yard a better spot to invest. Needless to say, the shifting winds have big implications for markets at home and abroad.

Mark Cliffe Chief Economist ING Barings

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For today's Daily Interview, we talked to Mark Cliffe, the London-based chief economist for ING Barings, about some of the factors behind the relative strength of the eurozone economy. The investment bank expects the eurozone to grow about 3% this year, compared with its estimates for growth of around 2% in the U.S. (Keep a lookout for a coming Daily Interview with an equity strategist on specific stocks and sectors that are poised to benefit.)

TSC: How are expectations shaping up for the European markets this year relative to the U.S? And what are some of the factors that will play into their performance?

Cliffe: One of the ironic things about the arrival of monetary union is that, far from allowing European markets to declare independence from the U.S. markets, they have tended to follow it as slavishly as before, if not more. Historically, if the U.S. markets fall, the European markets will fall more. If the U.S. markets [rise], there's a tendency for the European markets to outperform. There was a hope that [after monetary union] the European markets would trade off their own fundamentals, rather than the back of Wall Street. But the situation hasn't really changed that much. We see that in both the stock and bond markets to varying degrees. The tone is still set by the U.S. market. So you should bear that in mind.

But there are some cyclical and structural differences. European economies have not decelerated anything like as rapidly or suddenly as the U.S. economy has done in the last few weeks and months.

There are several reasons for that. One is that the European economies are rather less sensitive to the behavior of the stock markets. Market capitalization is small relative to GDP, compared to the U.S. That means the wealth effect on consumption from declines in the stock market is rather smaller. There's also less of an impact on capital expenditure.

Another reason [the European economies have held up better] is that, despite the recent rally in the euro, they're still benefiting from the previous depreciation. The euro is still well below its launch, and accordingly, monetary conditions are relatively accommodating. Bank lending has been growing fairly rapidly; the housing market is fairly buoyant.

TSC: Do you expect the euro to keep rising?

Cliffe: It's faltered in the last two days, but if the situation in the U.S. deteriorates in the short term, we probably will see a rally again. We expect it to hit parity against the dollar.

But looking ahead into the second half of the year, if we do see the U.S. economy continuing to rebound, courtesy of a policy easing from the Fed and tax cuts from the Bush administration, we would probably expect to see the euro's rally stalling. So I think the best period for the euro will be in the first half of the year.

TSC: Aside from currency issues, what are some other factors that would affect economic performance?

Cliffe: The tech sector is relatively small in Europe, so they're less affected by the downturn in that area. Tech spending is expected to grow almost as rapidly as last year.

Another thing I would note is that the eurozone economies are not particularly dependent on exports to the U.S. Most of the exports are to each other. That's also supportive. Unemployment is falling across the region, and that's helping sustain consumer confidence. Consumer confidence has risen slightly in the last month or two, in stark contrast to the U.S.

Fiscal policy has already been relaxed, whereas in the U.S. they're still waiting for [President Bush] to push through significant fiscal relaxation. In Germany, they've already had tax cuts pushed through -- and certainly in France, and a number of other countries.

TSC: And they've had significant tax cuts within the last year or so?

Cliffe: Yeah, this year, in part because of major elections in the next year or two.

TSC: So what level of growth do you expect from the eurozone?

Cliffe: We expect to see about 3% growth this year in the eurozone, compared with 3.5% last year.

TSC: So what are people expecting to see in terms of market performance in Europe? Is there any kind of consensus?

Cliffe: The question is how wide is the consensus of opinion, which is extraordinarily wide. You see probably the biggest differences in opinion in the U.S. today in probably a decade, which is not surprising. People are racing to the bottom in both their projections of economic growth and corporate profitability. To some extent, the same thing is happening in Europe. And it's hard to imagine Europe will rally strongly without seeing some kind of lead in the U.S.

So we do need to see further interest-rate reductions from the Fed and sustained rallies in the U.S. for European markets to pull along strongly, but I would be generally bullish for the performance of the European market for the year as a whole.

It will be extremely volatile in the short term. That's one confident prediction you can make. As far as U.S. investors are concerned, they will have the additional kicker of a currency gain, in stark contrast to the previous two years, when they made losses on European currencies.