ABN Amro takes a bullish view of the state of the European economy. While there is some link between US Federal Reserve interest movements and European Central Bank decisions (or, prior to the ECB, those of the Bundesbank), the Dutch bank’s economists believe that market expectations of a 75 basis point cut in euro rates in the first half of this year are exaggerated; they expect no more than a quarter-point cut. The bank looks for a recovery in the world economy in the second half of the year and doesn’t expect the eurozone to slow as much as the US. This latter argument is partly supported by the proposed tax cuts in many European countries that are expected to boost consumer confidence and spending. European households are also less debt-laden than those in the US, and are less dependent on stock market bulls.
Analysts at Schroder Salomon Smith Barney expect the growth of gross operating profit among non-financial corporates to rebound to around 7% in 2001-02; in 1999-2000 it stagnated before recovering somewhat last year. SSSB looks to economic growth, lower input costs, tax cuts and low interest rates to underpin bottom lines. SSSB also notes that there’s been a drive on the part of European countries to compete for capital by lowering corporate tax rates – notably in Italy, Germany and France. This trend is expected to continue, boosting after-tax profits and raising the return on capital.
The firm notes that eurozone debt-equity ratios are low enough to reduce corporates’ vulnerability to slowdowns and higher interest rates. Nevertheless, while corporate debt-to-GDP ratios are similar in the US and eurozone, at around 45%, SSSB believes debt-equity ratios are now more likely to rise in the US, as weakness in equity markets makes this source of capital less attractive.
Like their Dutch counterparts, analysts at SSSB are sceptical that the widely-predicted three-quarter point rate cut in the eurozone will appear as early as Q1, if it appears at all. SSSB argues that, contrary to past US slowdowns, the euro is significantly undervalued this time around.
With indicators pointing to a return of eurozone GDP growth to around 2.5%, SSSB notes that it would take a severe slowdown over several months, or a sharp rise in the euro, to spur the ECB into action.
Moreover, the firm points to reduced exposure to equity losses in the euro-area as an important cushion against European slowdown. US market capitalisation represents 139% of GDP compared with 80% in the euro-area.
As a consequence, total losses in equity value from March 2000 were 26% of US GDP and only 9% in the euro-area. Euro wealth was also less exposed to the decline of tech stocks last year, with capitalisation of Nasdaq representing 35% of GDP versus about 4% for Germany’s Neuer Markt.
However, it is not all good news from the SSSB camp. Its analysts predict that the first casualties of a pronounced US slowdown will be eurozone exports and business investment. European exports to the US comprise 15% GDP, with a 28% increase in exports to US realised in the first three quarters of 2000. SSSB argues that a 5% downturn in the US market will automatically produce a 0.2% downturn in euro-area GDP.
In contrast, Credit Suisse First Boston is eagerly anticipating euro rate cuts and citing immediate ECB action as the key to global recovery. CSFB’s forex strategy team expects a change in what it terms the “hawkish tinge” in the ECB’s recent announcements.
CSFB is gloomy about the immediate financial health of the US though, noting that 2000Q4 data suggests GDP growth of 2.0%, 0.7% less than CSFB’s original estimates. Risk is also growing, it says, of growth levels falling to zero for 2001Q1. Consumer confidence is much to blame, with a big fall in December auto sales and holiday spending.
Richard Davidson of Morgan Stanley Dean Witter is similarly downbeat about the US economy, predicting a further full point interest rate cut before July, with the ECB predicted to cut rates in March, and possibly again in the second quarter.
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MSDW isn’t enthused by the Fed’s rate move. It claims that boosting confidence does nothing positive for US GDP growth expectations and feels it unnecessary to alter its prediction of 3% earnings-per-share growth during the first half of 2001. But this leaves MSDW’s 7% full-year prediction (already down from 10%) looking shaky.
Another MSDW analyst, Richard Crehan, is deliberately pessimistic – he has a year-end target increase of 6,650 for the FTSE-100. That’s a mere 7% rise, compared with the consensus forecast of a 16% rise (7,200). Bearishly bullish, you might say.