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Triumph in Europe

At a time when interest rates rose, the pace of economic growth slowed and stockmarkets sagged, it is not surprising that defensive stocks did best in Europe during 2000.

Three out of the four best-performing sectors during the year were beverages (up by 36.2 per cent), pharmaceuticals (28.8 per cent) and food manufacturers (28.3 per cent). Nor is it surprising perhaps, given the monetary conditions that prevailed for most of the year, that insurance (up by 30.5 per cent) should be the fourth-best-performing sector.

What was surprising was the extent to which the European Central Bank overestimated the effect on inflation of a rising oil price and jacked up interest rates at precisely the wrong time. As it happens, the impact on inflation was not only illusory but the price of oil quickly came down.

Indeed, despite one of the coldest Decembers on record in the US, the price of Brent crude fell from $30.8 to $22.6 a barrel. Not even news that the Saudis were seeking an output cut of 1.5 million barrels per day has caused the oil price to perk up again.

That, together with the fact that December saw a sharp appreciation in the value of the euro, most dramatically against the dollar, should enable the ECB to abandon its policy of brinkmanship with the currency markets and to cut interest rates again. Such a move, when it comes, will not be before time.

The recent news on Euroland&#39s economy has been mixed. The growth in the services sector is likely to slow to 2 per cent by mid-2001 compared with 3.5 per cent six months ago. In December, consumer confidence and car sales both fell, the latter for the sixth month in a row.

Yet the unemployment rate declined from 9.1 per cent to 8.8 per cent, thanks mainly to strong declines in Italy and France.

Such a picture is reminiscent of previous periods of international stress, such as the Asian and Russian crises, when the rate of job creation in Europe held up well. Indeed, the strength of European companies&#39 balance sheets suggests that the region could well prove to be a haven of dependability for investors during a time of possible turbulence.

Europe&#39s equity markets have escaped the worst of the collapse in earnings seen in the US. Yet recent results in Europe show beyond doubt that the euphoria associated with dotcoms has evaporated.

Take the example of Intershopp, Europe&#39s leading application service provider. Having been the darling of the sector, the company forecast revenues for the fourth quarter of last year of t30m and net losses of about the same. The shares promptly fell by two-thirds in value.

As a result, established companies competing with the dotcoms can comfortably afford to delay their plans for capital expenditure. The telecommunications companies and equipment suppliers are unlikely to make up the shortfall in spending. Both sectors continue to feel the pinch.

Last year, if you were brilliant, you would have sold your shares in technology, media and telecommunications in March and bought defensive stocks in June. We sold most of our TMT stocks in March but were a bit slow to buy defensive ones because we were distracted by the merits of mid-cap stocks.

This year, investment style is important. This is because the choice of which style to favour is largely determined by the prevailing monetary conditions.

This year, inflation should come down along with interest rates. So, in theory, investors will be paid to take on more risk because central bankers are trying to reflate their economies.

The dilemma for stockpickers over the coming months will be to what extent they should discard the defensive mantle donned in 2000 in favour of a more entrepreneurial stance. Three things will determine their choice.

First, how structural, rather than cyclical, the problems in the US economy prove to be.

Second, the severity of the over-supply of product and equipment for New World companies following the misallocation of capital during the technology bonanza that ended last year.

And, finally, how quickly the European Central Bank decides to ease monetary conditions and to what extent such a move may be forced on it by a lower or falling dollar.

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