Market Outlook - Europe excluding the UK - Richard Pease


Stockmarkets in Europe excluding the UK ended the first half of 2008 in the same vein as they began the year; heading downwards. The two months of gains from mid-March were wiped out in June with investors spooked by deepening recession fears coupled with rising inflation. As forecast at the start of the year, conditions have been choppy and a defensive stance will have provided some shelter.

Data at the end of June showed the extent of the headwinds facing corporate Europe. Several economies contracted in the first quarter with Denmark the first in the European Union to fall into a technical recession. High oil prices, strong exchange rates, weakening global growth, falling house prices and tight credit conditions were all behind the recent stockmarket falls. The challenging environment did not, however, prevent the European Central Bank from raising interest rates in early July to combat the threat of inflation. Italy, Spain and Ireland are believed to be among the markets most at risk of following Denmark's lead. Germany provided one of the few bright spots, with its economy expanding 1.5% in the first quarter.

A degree of comfort can, however, be taken at a stock level. Company statements have become more circumspect but the message being conveyed by managements is cautiously optimistic. Earnings results so far in 2008 indicate that companies outside the financial sector are doing reasonably well. This is reflected in many of the companies the fund has considered for investment having underlying free cash flow yields approaching 10%.

In the current environment it is more important than ever to focus on sound companies with strong pricing power. For the New Star European Growth Fund this has meant avoiding businesses that depend on discretionary spending and the portfolio has a reduced exposure to cyclical holdings as well as financial stocks. Instead the emphasis is on robust companies that have relatively stable earnings and that trade on undemanding valuations. These should be capable of growing regardless of the wider economic picture and, importantly, have the potential to bounce sharply when wider investor sentiment improves.

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