Econ Paper

#1 Essay, Research Paper

Lagging Earnings, Interest Rates Make Year-End Rally Unlikely

Many European fund managers aren?t going to find anything good this Christmas to be merry about. In most years, particularly lackluster ones, there seems to always be the year-end rally that puts the fund managers performance up to the standard. And makes the woes of the year?s financial problems on either side of the Atlantic a little easier to swallow. To be sure, this hasn’t been a year for the books. The DJ Stoxx 50 has inched up a miserly 0.8%, and the DJ Stoxx index is down 0.5%, with European stocks largely stuck in a trading range since March. Some investors had been hoping summertime concerns over interest-rate increases and disappointing corporate earnings might dissipate in the autumn, but the fourth quarter has so far squelched such expectations.

?Year-end rallies are very popular,? says George Hodgson, a European equity strategist for ABN Amro in London. “People think that they always happen and are bound to happen, especially this year because of the dull start to the fourth quarter. But they are more notable for their absence than anything else.”

From what I gather, the main concern is the interest rates. Many had been hoping that by the end of the year, there would be a possible rate cut in early 2001. But instead, experts expect the rates to continue to rise into early first quarter of next year. In turn, this is smothering the European equity markets and is putting upward pressure on bond yields. The central banks are greatly surprised by inflation and aren?t in any rush to cut the rates. Acutally, when the U.S. Federal Reserve meets this week, it is expected that they are going to raise the rates at least one more time before they consider lowering it.

The other main concern for equities is earnings, which continue to disappoint analysts, which in turn, causes them to lower their profit forecasts for next year. The two main factors behind the dissatisfying earnings:

1. A slowdown in European growth.

2. Lofty oil prices.

These aren?t showing any signs of improvement, and many top experts continue to be cynical about the coming earnings reports. “We think the concerns about earnings will keep on resurfacing,” says Roger Beedell, European equity strategist with BNP Paribas. “We have been seeing short-term rallies, but then they seem to get knocked on the head by more earnings news.”

There are, however, others who believe the current macroeconomic scenario will be more positive. For example, Kevin Gardiner, a strategist with J.P. Morgan, argues that bond yields are now largely stable, having already priced in the coming rate increases and, therefore, shouldn’t weigh on equity valuations. He also believes the market is overly pessimistic about earnings growth next year. He believes the oil prices have slowed down the economy, yes, but also believes that it will have a fleeting effect. Mr. Gardiner expects the pan-European stock indices to gain around 10% over the next two to three months.

The state of the world?s economy is in disarray and some analysts think we have nothing to worry about, while others tell us to get ready for even higher interest rates early next year. I am not an expert on the matters, but I have total faith in the markets and think we should not worry too much about it. Everything seems to work itself out.