Against a backdrop of plummeting consumer confidence and the announcement of a number of layoffs in the U.S., some market watchers are taking a closer look at European markets. We talked to Graham Secker, a London-based equity strategist at
Morgan Stanley Dean Witter
, about why he thinks the fundamentals look better for growth in Europe, and how investors might play the eurozone markets.
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TSC: To start with, could you touch on some of the factors that stand to help the European markets this year, relative to the U.S.?
: Europe is obviously a relative safe haven compared to the U.S. in terms of the macroeconomic environment. We're among the most bearish banks on the Street
on the outlook in the U.S.. We're going for a hard landing, whereas most are going for a soft landing. We've got U.S.
GDP falling to 1.1% year on year for 2001, with two negative quarters, Q1 and Q2. So the U.S. is going to go into recession.
Europe in a better position because Europe is not going to have a recession. One of the key reasons we're relatively happy is because of the fiscal situation, because large numbers of tax cuts were happening throughout Europe. That's happened in Germany and Italy, and in Spain and France it's likely as well.
The U.K. situation is not quite the same. We're not expecting any large changes to the tax regime here, but what we do have is a comprehensive government spending review. So we'll have a lot of investment in infrastructure and schools and hospitals. We're forecasting 2.1% GDP in the U.K. for 2001. Now 1%, or half of that, is due to government spending. That's a nondiscretionary item; it is going to happen.
So you've got that in the U.K. and continental Europe has got tax cuts. So that gives you a chunk of GDP that is going to happen anyway. That's something the U.S. hasn't got. Because of these factors, consumers should stay relatively strong in Europe and the U.K. as well. Europe's going to do better because growth is not as weak as the U.S.
TSC: So what are some sectors in Europe you like at this point? And some sectors you'd recommend staying away from?
In terms of sectors, obviously interest rates are due to come down. You had a
cut of 100 basis points in the U.S., and we expect another 100 in the next six or seven months. We expect 75
basis points cut from the European Central Bank and the MPC, the U.K. central bank. We're buying interest rate-sensitive sectors, so obviously the banks and insurers and asset gatherers.
Another key area is telecoms. The reason for that -- why they're interest rate-sensitive -- is they're very highly indebted.
TSC: Your colleague, Richard Crehan, just wrote a report looking at how European banks could be hurt by telecom debt. That wouldn't make you want to stay away from telecoms?
The whole point of the note is to say, actually, the chances of it really affecting a bank are remote, because this debt is relatively widely spread out. The majority of debt is investment-grade, and it is not going to default. It's your very dubious carriers with skimpy business plans that are going to go bust. Of telecom and tech debt, in the past year or two, only 5% of this is noninvestment grade. And of that, only a small proportion is really at risk. A worst-case scenario, maybe 5% would default. In the grand scheme of things, that's not an awful lot, because it's spread over so many banks.
Banks may selloff a little bit, if the issue really takes hold. But it's unlikely to have a sufficiently detrimental effect. So if they do selloff, you'd have the opportunity to buy them cheaper than normal.
TSC: What are some stocks that you like within those sectors?
Our main telecom plays are
Cable & Wireless
In financials, our top pick within Europe is really
. We also like
and some of the Scandinavian banks.
TSC: How about on the selling side?
At the other end of spectrum, what are we selling? We remain very cautious on the cyclical outlook, for the reason that we're obviously got a very bearish macro view on growth. Though the valuation of these
cyclical stocks is undoubtedly cheap, we've got to look for a big catalyst. I think the run in the last month or so will be a false dawn. We don't know how bad the growth situation is going to get in the U.S. So we've got to see the bottoming of growth in the U.S. before we get too eager to get back in areas like capital goods, the industrial cyclicals or some of the consumer cyclicals.
TSC: So you think some of those stocks have just moved up prematurely?
Some are up 20%, 30% recently, and I can't see why.
is very cyclical and it's had a great run recently. Airlines are one of the most economically sensitive sectors, British Airways is highly exposed both to North America and premium traffic. It's going to suffer substantially in a downturn. Maybe it's not the right time to bounce.