As America's economy comes up for air, Europe prepares to plumb the depths

As America's economy comes up for air, Europe prepares to plumb the depths

Last week, we wrote that investors were becoming more interested in the US despite the worsening economy, threat of rising interest rates and a weakening dollar. Europe is almost the mirror image; its major economies, Germany in particular, are relatively robust; its currency has risen sharply against both the dollar and the pound and is expected to continue to do so; its consumers have, for the most part, avoided the debt finance binge America and Britain have indulged in; and, outside Spain and Ireland, the housing market is not on the brink of collapse.

Yet, while investors think America could be getting over the worst of its downturn, they fear Europe is only just beginning. Feras al-Chalabi, manager of the CF Odey Continental Europe fund, thinks that the 8 per cent or so growth forecasts by analysts for this year will prove too optimistic and warns that earnings could be flat at best and maybe down as much as 6 per cent, with more of the same in 2009.

'It's hard to find a time in history when there has not been two poor years after a peak,' he says. 'Revenue growth is hard to come by and Europe only recovered in early 2005, while the UK and US have enjoyed five years of rampant growth.'

While earnings growth in 2006 was driven by cost-cutting and restructuring, costs are now moving against companies. The rise in commodity prices is hitting European companies, too, though the impact has been reduced by the strengthening of the euro against.....continued below

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the dollar, the currency in which most commodities are still priced.

German steel workers have won 6 per cent rises, government workers 8.5 per cent and rail unions are holding out for 11 per cent. Those kind of increases are adding further fuel to the inflation figures, putting pressure on interest rates. And, while US companies are enjoying rising exports, courtesy of their weak dollar, European businesses are suffering from the euro's strength.

Al-Chalabi also thinks Europe is only just starting to suffer the worst effects of the credit crunch. He estimates that around 60 per cent of European company debt comes from banks - in contrast to Britain, where corporate bonds are increasingly popular - and are seeing their rates and loan terms being dramatically tightened by cash-strapped banks. Defaults, he says, generally follow six months later.

But he still thinks there are interesting investment opportunities in Europe. He looks for industries facing opportunities not yet reflected in share prices. At the moment, that includes things such as electricity, where years of underinvestment means prices are rising sharply, agriculture, also driven by rising prices, and food. 'Any industry still managing to increase prices in this difficult environment is what we are looking for.'

Tim Stevenson, of Henderson's Eurotrust, thinks that European companies have a 'different timescale and ethos' to British ones. They think long-term, rather than short. 'The result is that the UK is left with weak infrastructure and companies with thin balance sheets. But the European companies have sound balance sheets and are prepared for stormy weather.

Among his preferred companies are industrial groups such as Atlas, Copco and ABB, but he has become even more cautious about consumer businesses, selling Nokia, for example, as it seems incapable of coming up with a decent consumer alternative to the Blackberry.