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Steady as she grows

Market sentiment in Europe has swung from depression to a much more relaxed or even enthusiastic view over the last 12 to 18 months.

But while it seems likely that the economic news will continue to improve, we cannot assume this means a return to rapid growth. The environment remains extremely difficult, with external influences likely to pose the biggest threat. My working assumption for the next few years is that we will see a prolonged period of low growth throughout Europe.

Low growth is not necessarily a negative. Continental European markets are just too mature and constrained to be able to show the kind of growth which was seen for much of the 1980s and 1990s.

It does mean that a tempering of current enthusiasm might be prudent. As gloomy sentiment at the beginning of 2003 proved to be excessive, I believe the reverse is true now.

At a stock level, the biggest threat to European markets comes from the US. There has been much talk of the effects of the weakening dollar on European companies. Many of them have a significant US exposure, either because they are multinational and have earnings in dollars or because they export to the US and derive a portion of their earnings from there.

The dollar has weakened considerably but I think it will go further. The risks will become of greater concern if any further slide happens more quickly than expected. Markets will take a gradual decline in their stride, even to 1.4. But if that slide happens more suddenly, I think markets might feel more nervous. This is an issue we need to keep a close eye on but not one to get too anxious about for the time being.

In this new low-growth era, we need to look more closely at the valuations of the companies identified. In the aftermath of the last technology bubble (and arguably in the midst of the next) it has undoubtedly become more difficult to identify true growth companies and then assess how the market will choose to evaluate them.

We have taken a more pragmatic view. There are plenty of good-value growth companies in Europe but there are a number of factors to consider if you want to separate them from the more expensive growth companies, which may still be worth holding but for different reasons.

Generally, patience and faith in the intrinsic value of a company should be rewarded.

I believe the steady growth stories, some of which are categorised as defensive, will win out in this environment. These have tended to underperform in the recent rally, which has been led for much of the time by disaster recovery situations, so valuations have come down, providing some good long-term potential.

Many European companies have undertaken some dramatic cost-cutting exercises in recent years. Coupled with an improvement in the top-line growth as demand recovers, this is a strong combination.

Other themes that should be interesting and provide good long-term potential include the growth in savings and the shift in consumption styles. Aegon and Skandia remain examples of companies that should reap the rewards from the increased need for long-term savings. These areas, along with more well-used growth themes such as outsourcing, restructuring and selected technology plays, should be where growth is found in the next few years.

In the last few months, we have seen more companies coming to the market with placings and rights issues. This broad-based capital raising may offer further opportunities but I will be very selective about these.

In a low-growth environment, total return becomes more important. An active fund manager should get better growth than the market. A growing dividend can add a good deal to this bottom-line growth for investors.

In this environment, patience is crucial. If you believe you have identified good companies, you should let the management get on and prove their worth. Fund managers are bombarded by outside influences that can make us doubt our decisions but the good companies will nearly always reward patience. If you get it right, investors benefit from a much lower turnover within the fund.

Overall, I feel optimistic about the prospects for investment. We are seeing a much more favourable economic situation. Much of the necessary cost-cutting has been done and improvements to earnings and potential long-term growth are taking place. There will be challenges, such as the dollar, but this is reflected in reasonable valuation trends.


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