Market Outlook - Europe excluding the UK - Simon Rowe

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Simon Rowe, co-manager of the New Star European Growth Fund, comments below on the recent stockmarket volatility, his outlook for Europe excluding the UK and stock specifics. The New Star European Growth Fund is lead managed by Richard Pease and is AAA-rated by Standard & Poor’s*. 

The fallout from the US sub-prime lending crisis and concerns about a US economic slowdown continue to affect sentiment towards European equities. Markets have remained volatile since the credit crisis began to unfold and, although overall stockmarket levels have held up reasonably well, companies with US or cyclical exposure have been hit hard, almost without regard to their track records, business models or future earnings expectations for 2008.

The banking sector has been particularly weak in response to concerns about the impact of the freezing of the commercial paper market and write-downs on bridging loans for mergers and acquisitions activity. Many investors also feel that financial companies have been less than fully open about their exposures to problem areas. Among industrial companies, especially cyclical businesses, there have been increasing concerns about exposure to the US.

While uncertainty about US economic prospects is the largest factor driving investor sentiment, it is yet not clear exactly how sharp an economic slowdown the US will experience; nor is it clear whether it will be large enough to have a significant impact on the eurozone. Indeed, it is going to take some time before investors are able to see how developments in the US will pan out and whether this will have a material effect on European corporate profits.

Some comfort can be derived from the fact that Europe’s reliance on the US has reduced in recent years because sources of new demand have emerged for exports from the eurozone. Exports to the countries that have recently joined the European Union are as large in absolute terms as those to the US. Add to this the rapid growth in Russia, India and China, and Europe’s historical reliance on US consumers has been significantly reduced. Europe is also traditionally strong in the production of the capital goods that the developing world needs to maintain rapid industrialisation.

For now though, stockmarkets are likely to remain volatile, driven more by sentiment than fundamental corporate prospects. Valuations in some sectors more than discount a sharp European economic downturn. Third quarter earnings reports, which start being published from mid-October should, therefore, restore some confidence and help investors to discriminate between those businesses exposed to the specific problems of the financial sector and those with more robust prospects.

Stock specifics

CGG Veritas

The long-term story for oil remains strong and CGG Veritas, which provides geophysical services to oil and gas companies, appears well-placed. The company was trading on a 2008 p/e of about 14 times in late September and demonstrates solid pricing power. As demand strengthens for oil and gas reserves, the equipment required to locate new sources has to be increasingly sophisticated. CGG Veritas is a leader in its field.

Food retailers

Food retailing companies have demonstrated some resilience in recent months. The French supermarket chain, Carrefour had a relatively strong nine months. Shareholder pressure has forced its directors to focus on returns on capital. In response, Carrefour is in the process of selling underperforming businesses and proposing to float a chunk of its property assets. This has helped lift the share price. The Dutch supermarket group, Ahold, and Delhaize, the Belgian owner of US supermarket chains such as Food Lion and Hannaford, have also held up well. Sodexho Alliance, the food and facilities services contractor, is one of the few companies able to deal with large outsourcing contracts and maintain a stable stream of revenue. Its shares have recently been hit by concerns about rising food costs although it is likely that it will be able to pass these on to clients as it has done in the past.

Anglo Irish Bank

Anglo Irish, which partly acts as a specialist lender to property developers, has been marked down on expectations of reduced growth in Ireland and challenges for the wider commercial property sector. Anglo Irish, which at the end of September was trading on 8.9 times September 2008 earnings, was also affected by the Northern Rock crisis even though the profile of its funding is completely different. The level of caution in the market was such that even a positive trading statement announcing full year earnings likely to beat expectations provided little comfort. Anglo Irish may benefit from increased custom as competitors become unwilling to lend and management remains confident.

*At 28 September 2007

Past performance is not necessarily a guide to future performance. The opinions expressed here represent the views of the fund manager at 28 September 2007 and should not be interpreted as investment advice.

The value of investments in the fund may fall as well as rise as a result of market or exchange rate movements. This document is for professional advisers, professional investors and financial institutions only and is not to be relied upon by private investors. Issued by New Star Investment Funds Limited.