F&C: Growth likely to be stunted for sometime

Having enjoyed a significant rally since early March, European equity markets appear to think that the recession is over and that normal business is resumed.

Crispin Longden, manager of European Assets Trust, begs to differ. "On the economic front, green shoots may be sprouting," he explained, "but their growth is likely to be stunted for some time to come."

He points out that while leading statistical indicators are improving, they remain materially below the divide between absolute growth and decline. Unemployment rates are rising rapidly across Europe and company management does not share the unbridled optimism of the stockmarkets.

"In the recent spate of reported company results in Europe, profit warnings have been just as frequent as positive surprises," Longden said. "The emphasis is on cash conservation with companies postponing discretionary spend and capital expenditure levels falling well below depreciation."

Yet analysts, infected by the markets' optimism, have recently started to revise up their profit estimates for 2010 to levels that, on lower turnover, imply record operating margins.

"As recently as 2001 when Europe last suffered a downturn, arguably far less severe than the current one, operating margins fell well below 10%. The 2010 forecasts suggest operating margins north of 13% while industrial production in Europe is still falling by an unprecedented double-digit annual percentage," explained Longden.

The manager backs his cautious view of current market levels with a comfortable cash cushion of over 10% in European Assets Trust. Even allowing for this, the Trust outperformed its benchmark index, HSBC Smaller Europe (ex UK), in the first six months of the year thanks to positive stock selection. Longden said the sheer number and diversity of European companies in the small and medium-sized asset class offers plenty of scope for an active stock picker irrespective of the overall market backdrop.

Longden has used the recent stock market strength to reduce an overweight position in capital goods, which he regards as late-cycle and prone to underperformance should economic recession prove protracted. The Trust is also underweight banks given a poor outlook for credit growth and the likelihood of a major pick-up in loan defaults. With the available cash balance and the ability to gear European Assets Trust to 20% of assets, Longden is ready to pounce should share prices fall back again.