The following was also reported in the WSJ. A bit of a plug here for Dave Abramson the BCA source. Went to school together - he's pretty smart and BCA are good.
LONDON--Well, what do you know: The European Central Bank finally cut interest rates again -- by half a percentage point to 3.25%.
It's about time. After all, euro-zone unemployment is rising, inflation is falling ... as is economic growth, consumer confidence, business confidence, industrial orders, corporate pricing power, new business, construction, capacity utilization and who knows what else.
Don't forget, these are the guys -- and one gal -- who said their half-point reduction to 3.75% on Sept. 17 would be sufficient to offset the shock of the Sept. 11 terrorist attacks.
If you divide the world into those who like extended foreplay and those who prefer more rapid pleasures, the ECB is clearly in the former category. For instance, the U.S. Federal Reserve, confronted with the same strains as those facing the ECB, has cut its key federal funds rate 4.5 percentage points in 2001 to a 40-year low 2%, compared with the ECB's 1.5 points in reductions.
The big question facing investors, workers and business execs is whether the crew that hangs out in Frankfurt will ever achieve satisfaction.
Until now, they've been the recipients of considerable scorn. "The ECB still looks frightened by its own shadow and still hamstrung by its own lack of monetary conviction to go in harder with more aggressive cuts," David Brown, chief European economist at Bear, Stearns & Co., told clients last week. In a poll of 73 U.S. fixed-income managers conducted by Ried, Thunberg & Co., 62% attributed the ECB's failure to lower interest rates in October to a plain old "pigheaded mien."
Compared with the Fed's 4.50 percentage points of rate reductions, Shahab Jalinoos, a currency strategist at UBS Warburg, calls the ECB's cuts "a derisory return within the bigger picture of a global recession." Noting that in 1999, the ECB "cut rates to 2.5%, the lowest they ever have," he adds: "They still aren't at that level, and it can be argued the world was in better shape then than now."
In a speech nine days ago, ECB chief economist and board member Otmar Issing said, "All advice and calls to give up price stability as a priority will fall on deaf ears." Carl Weinberg, chief economist at consultants High Frequency Economics in Valhalla, New York, calls his comments "offensive, narrow-minded and ignorant."
OK. Enough banker-bashing. Although he accuses the ECB of being "asleep at the wheel," David Abramson, European strategist at the BCA Research Group in Montreal, says, "That's increasingly not the point. Inflation indicators are improving; unemployment is rising; and interest rates will get to where they need to go." Put simply, "The central bank targets inflation, and inflation is going to fall," he says, adding that the ECB's key refinancing rate could eventually tumble to 2.5% or even lower.
Nice, but what's all this mean -- apart from enabling you to lock in a cheap mortgage?
Mr. Abramson -- who, by the way, used to have a legitimate job as a Canadian central banker -- contends that a combination of lower rates, low inflation and investors' declining appetite for risk "is creating a mountain of cash that provides the potential firepower for higher European financial asset prices at some point in the future when confidence is restored." As rates fall, he argues that investors will conclude that "cash is trash" and seek higher returns elsewhere.
His favorites include European corporate bonds, which should benefit from lower rates, a decline in the yield gap at which they trade above euro-zone government bonds and European institutions' desire for higher yields than they can attain on government securities. Long-term, Mr. Abramson is bullish on small-capitalization value (low-priced) stocks, which he argues have been victimized by investors' increased interest in index-related products, which usually include mostly large-cap stocks.
He's also high on Germany's "Rust Belt" -- beat-up German industrial sectors, such as steel and chemical companies. Why? One, they're relatively cheap. Two, noting that taxes account for 51% of German labor costs -- compared with 31% for the U.S. and 30% for Britain -- Mr. Abramson believes that after national elections next year, the government could move to reduce that burden. Three, the weak euro benefits big German exporters.
What's more, it ain't just Germany. At 45% to 56% of labor costs, taxes in Belgium, France, Italy, Austria, Finland and Sweden are at or above the 45% European Union average. And once a big country, such as Germany, lowers taxes, Mr. Abramson believes others will follow. "It'll take time," he says. "This is a long-term story, not one for just the next six to eight months, when election politics will dominate in France and Germany."
Technology, media and telecom? Mr. Abramson advises that investors steer clear, unless they fancy themselves whiz-bang traders (i.e., this stuff isn't for Aunt Tilly, Grandma Hildegard or your kid's education fund).
Rather than shoot off at the mouth, this guy's ideas come from analyzing the U.S. recession of the early 1990s and the early 1970s when the "Nifty-Fifty" growth stock bubble burst, not unlike the Nasdaq market's woes of the past 19 months.
In 1992 and 1993, liquidity was plentiful, consumer confidence in the dumps and the rate-of-return on U.S. assets declining. Sound familiar? And like Europe now, Uncle Sam was unwilling to increase government spending to help get the economy moving, leaving the burden to loose monetary policy.
The lessons: One, hold bonds; they remained overvalued until 1994. Two, it takes time for long-term sector leaders to emerge; the mega-trend in tech stocks didn't take off until consumer confidence recovered in mid-1993. And three, despite the extra liquidity, wait a while before investing in cyclicals.
And the early 1970s? "As stocks emerged from the bear market in 1975, investors stubbornly tried to pick bubble-era favorites at low prices," says Mr. Abramson. "It took several years before new leaders -- value and tech stocks -- emerged."
Meanwhile, Goldman, Sachs & Co.'s European strategists are telling their clients to stay defensive. "I subscribe to two simple views: One is that earnings expectations are too high; and, two, that the market is still overvalued," says the plaintalking American Mike Young, chief equity strategist.
In a report issued Monday, he and his buddies declare there is "a high probability that European equity markets will go lower before they go higher." Based on Goldman economists' prediction that European GDP will climb only 0.6% in 2002, while U.S. GDP falls 0.2%, Mr. Young expects average European earnings-per-share to fall 5% to 10%, compared with analysts' consensus projections of a 10% rise.
The Goldman team has designed a model portfolio, which, they believe, will outperform the market as a whole, if growth is weaker than expected and bond yields lower than anticipated. See, investing can be an "I'm prettier-than-you-are" contest. They estimate it can outperform by about 1.8 percentage points, if Group of Seven major industrial country growth is 0.2% in 2002 instead of a consensus projection of 1.1%, and the yield on euro 10-year government bonds is 4.1% compared with the consensus 5.1% forecast.
Back testing shows that the 51-stock portfolio would have outperformed during the 1987 crash, the 1990-1991 Gulf War and the 1998 liquidity crisis. It would have underperformed in 1994 and early 1995 when the Fed raised interest rates. The Goldman strategists believe the portfolio isn't overvalued relative to the market as a whole and is fairly well insulated from negative earnings revisions.
Relative to its FTSE-Europe index benchmark, the portfolio's biggest sector overweights are diversified industries, beverages and tobacco, telecom services, pharmaceuticals, insurance and food retailers. Its biggest underweights are energy, engineering, information-technology hardware and banks.
Among the overweights, Goldman analysts like what are basically two utilities: France's Suez and Germany's E.On, along with British American Tobacco and brewer Heineken. Other favorites are insurers Axa, ING Groep, and Munich Re; and food retailers Ahold and Tesco. When it comes to telecom companies, the model portfolio includes Vodafone, Telefonica, Deutsche Telekom, Telecom Italia Mobile, Portugal Telecom and Swisscom. Its pharmaceutical favorites include GlaxoSmithKilne, AstraZeneca, Elan, Aventis, Celltech Group and Novo Nordisk.
Still, some folks keep singing the blues. Michael Belkin, president of Belkin Ltd., a Seattle firm that uses computer models to forecast financial-market trends, notes that the business cycle usually produces mild downturns roughly every four years but that Fed liquidity injections forestalled downturns in 1994 and 1998, creating a tech bubble, overinvestment in housing and unrealistic investor expectations.
"The problem now is we have three recessions worth of mal-investment to work though," says Mr. Belkin. "So, don't be surprised if lower rates can't quickly restore economic vitality." |
