This is no time for playing the hero

Reasons to be wary about the performance of European companies can be found in abundance, but experts suggest that a step-by-step approach to rebuilding equity positions is the best strategy.


Until markets fully recover, investors should deal with equities in the eurozone in the same way people act when they go to a swimming pool.

First, test the water by dipping toes in. If it is not too cold, put the whole foot in. If the shock of temperature change is bearable, in goes the other foot. Then shins, knees – and eventually the lower body gets wet. After some time, when comfortable with the whole process – take a dive.

That is the advice of Udo Rosendahl, the head of European equities at Germany’s DWS, a subsidiary of Deutsche Bank, for investors thinking of putting their money back in eurozone companies. Caution and tentativeness are the best approach right now, he says.

Reasons to be wary about the performance of European companies are one thing you can find in abundance at the moment. A mix of factors such as the widespread economic downturn, the bursting of property bubbles in several countries, and reluctant consumers has darkened the perspectives for the eurozone in 2009. The global credit crunch has not helped the situation making eventual recovery even harder than it would normally be. Earlier this year it was still possible to argue that the eurozone would be able to ride an American-made financial mess relatively unscathed. Such optimism has proved wide of the mark.

Economic forecasts paint an ugly picture. In early November the European Commission downgraded its expectation of GDP growth in the eurozone to 1.2% this year and 0.1% in 2009. Unemployment will rise and public finances will deteriorate as governments try to spend their way out of trouble, the commission warned.

The credit crunch is fuelling housing market slumps – a particular problem in countries such as Ireland and Spain – which in their turn affect private consumption, weakening the prospect of a prompt recovery. It all sounds pretty bad, but not bad enough for the economists of the Organisation for Economic Co-operation and Development (OECD), which forecasts that growth will be only 1.1% in 2008, and that the region’s GDP will fall 0.5% next year. When a 0.1% forecast looks like a desirable proposition, you know that a tough market beckons, one in which even doom-mongers will struggle to make a good living.

So it is no surprise that confidence among economists is low, and stockmarkets have reacted accordingly. The main eurozone indices have fared poorly in 2008 – by November 20, France’s Cac 40 was more than 46% down on the year, a performance almost as bad as that of Spain’s Ibex 35, which shed more than 47% in the same period.

The main index of the Milan Exchange, S&P/MIB, reached as low as 18,600 points by the end of October, which is 20,000 points lower than in early February and a far cry from the record-breaking 44,364 posted last year. Even the reliable German market is faring poorly, with the Dax index losing almost half its value since January. Investors who are aware of such numbers could have either of two different reactions.

The most chicken-hearted could think it is better to stay at a safe distance from eurozone equities. The most daring followers of Warren Buffett would think that this is exactly time to follow the Sage of Omaha’s famous words: buy low, sell high.

For the experts, however, the clever thing to do is to stand in the middle of these two positions. That is what Rosendahl intends to show with his swimming pool analogy. “If I were an investor I would start building positions in equity markets again,” he says. “But I think there still are difficulties ahead of us, so the best thing is to invest in equities only step by step.”

That view is shared by Andy Lynch, the manager of Schroders’ European Dynamic Growth fund. “For the first time this year you can look at the market and say to yourself: value is starting to emerge,” he says. “If you are in the happy position of having cash, it is not a bad idea to start putting it back into the market month by month. I am sure we will look back in two or three years’ time to prices in November 2008 and say: ‘Gosh, they were really cheap’.”

But caution is still the best approach, Lynch says: stockmarkets may still have some way to go down as companies’ earnings expectations still look unrealistically positive.

For those eager to try to pick up some bargains anyway, Henk Grootveld, senior vice-president, European equities investment at Robeco, a Dutch asset manager, explains that the main targets should be companies with no need to make new debt. “The key now is the strength of balance sheets,” he says. “It is important to look at companies that have a growth driver, so they can continue to increase their revenues. But they must be able to fund that growth themselves, without going to the bank or to the markets.”

The sector where each company works is also important, as some are set to be hit harder by the recession than others. “The growth driver must be independent from the crisis areas, mainly housing-orientated sectors,” says Grootveld. “We see, for instance, interesting opportunities in pharmaceuticals and in some of the cyclical consumer stocks, like media, which is extremely cheap at the moment.”

Lynch, for his part, likes traditional defensive sectors such as utilities, telecoms and healthcare. “I am very underweighted at consumer discretionary spending right now,” he says. Sectors that Lynch’s fund is avoiding include automotive, luxury goods and holidays. “We will wait until next year is well under way to start looking at such areas again.”

“We can start to have a look at commodity markets and at oil companies too,” remarks Rosendahl. But he says not every industry that has suffered a battering is likely to provide good bargains for investors. He suggests staying away from banks for the time being, for instance.

Rosendahl finally stresses the need to remain cautious even if an investor is not taking the gloomiest predictions at face value. “Looking forward, things will get more attractive,” he says. “But you should not be the hero these days.”