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Quarter-End Insights

An Uneasy Calm for European Markets in 1Q

The markets took a stream of negative news and weak economic growth indicators in stride during the first quarter.

If there was a significant difference in Europe stock market action in the first quarter of 2013 compared with the previous few quarters, it was how little the major markets actually moved. And investors must be relieved, given the roller-coaster ride that equity markets took during much of 2012.

According to data from MSCI, for the quarter ended March 28, 2013, the French and German stock markets (Large + Mid Cap) lost 0.6% and 0.7% each, respectively. The UK markets gained 0.6%.

The year started on a positive note as equities logged minor gains by the end of January. Stocks were given a boost after lawmakers in the U.S. agreed on ways to avoid automatic tax increases known as the "fiscal cliff," and after ECB President Mario Draghi said economic activity was stabilizing and that he expected a recovery in the second half.

But the International Monetary Fund cut its global growth estimates to 3.5% for 2013, down from the 3.6% it had projected in October last year. The World Bank also lowered its forecast for global economic growth to 2.4% from an earlier estimate of 3% growth.

Economic reports, too, gave mixed signals, as data first indicated the eurozone's downturn eased in December and the final Purchasing Managers' Index rose to a nine-month high. But German GDP figures showed the region's largest economy shrank 0.5% in the fourth quarter, tempering investor enthusiasm.

With no definite cues to push the stock markets either way, politics took center stage for a while in February, as Italy held general elections that proved inconclusive, worrying already-jittery investors, while in recession-hit Spain, Prime Minister Mariano Rajoy was charged with corruption.

Adding to downbeat comments on economic growth made by the IMF and the World Bank in the previous month, the European Commission in February said it expected the eurozone to recover more slowly than it previously anticipated, returning to growth in 2014 and not in this year. The EC lowered its forecasts for the eurozone's GDP growth to 0.1% in 2013, compared with an earlier estimate of 0.3%.

In some positive news in the month, European Union leaders agreed on the bloc's 2014-20 budget of 960 billion euros, after a deadlock in November over the issue. But equities still gave back their gains from the previous month.

In March, the stocks markets in the world's largest economy rose to record highs after the U.S. Federal Reserve vice chairman Janet Yellen said the central bank would stick to its monthly $85 billion bond-buying program. Also, economic data released for the month of February showed an increase in retail sales as well as a bigger-than-expected rise in non-farm payrolls, which brought down the rate of unemployment.

But the excitement was short-lived as the eurozone crisis flared once again. Out of the blue Mediterranean, the tiny island nation of Cyprus shot into world headlines as investors awoke on a March morning to hear the country was planning to tax its citizens' bank deposits in order to raise funds of about 5.8 billion euros, a precondition to receiving international financial aid.

After hectic developments amid large-scale civil protests, much of them over the last few days in March and which are still ongoing, Cyprus reached a deal with its lenders to protect itself from bankruptcy. The country said it would raise the required funds though tax increases and privatizations, and--in an unprecedented move--by closing the Laiki (Popular) Bank, whose bondholders and depositors would face significant losses. Those accounts would be frozen and used to pay off the bank's debts.

In other negative news, economic data showed an on-quarter contraction of 0.6% for the eurozone in the fourth quarter and effectively shut the door on any hopes of a rise in the markets. In latest developments, Spain's highest court is overseeing the investigation into whether the ruling Popular Party took bribes from big companies, even as Spain's apex bank said earlier last week that the country will sink deeper into recession this year.

A month after Italy held general elections but failed to elect a new premier, ratings agency Fitch downgraded the country's long-term foreign and local currency issuer default ratings to BBB+ from A- with a warning of a further downgrade, citing political instability.

In another recent, significant development, European Union leaders rejected the proposed budget that they agreed to in February, as leaders within the EU demanded changes in the manner the money would be spent, and also the option to be able to raise the overall sum in future.

Looking ahead, while investors will be hoping that economic data from the eurozone begins to show some improvement sooner rather than later, they will also be on edge as U.S. lawmakers debate the "fiscal cliff" situation once more after temporarily suspending the nation's $16.4 trillion borrowing limit to May 19.

In conclusion, it's probably no exaggeration to say that while the European stock markets have not moved much in the last quarter, it has been an uneasy calm.

Stocks on the Move
Health care, information technology, industrials, telecommunications, consumer staples, and consumer discretionary companies all logged positive gains in the first quarter.

The health-care segment was among the best-performing across Europe, with major companies such as GlaxoSmithKline PLC (GSK) and AstraZeneca PLC (AZN) gaining as much as 13% each over the quarter. Both U.K.-based companies announced measures to turn things around in the face of declining sales, while AstraZeneca, under a new CEO, also reorganized senior management and announced a global restructuring resulting in a reduction of head count by approximately 2,300.

Over in Paris, Sanofi SA (SAN) was up 11% along with a 12% advance for German drug major Bayer AG (BAYN).

In the consumer staples category, household and personal products, and food products and beverages were among the strong gainers. Retailers also performed well, with stocks such as Tesco PLC (TSCO) gaining over 13% and J Sainsbury (SBRY) up over 9%. Carrefour SA (CA) picked up more than 10%.

In information technology, among semiconductor firms, British microprocessor designer ARM Holdings PLC gained about 20%, while its peer STMicroelectronics (STM) was up 14%. In Frankfurt, Infineon Technologies (IFXA) only managed a marginal 2.6% gain.

Software and services firms had a lackluster quarter, with companies such as SAP AG (SAP) up a marginal 3% while Cap Gemini SA (CAP) gained only 8%.

Among financials, only insurers logged positive returns over the quarter, while banks, at the heart of the euro crisis, generally fared badly. French banking groups BNP Paribas (BNP) and Societe Generale SA (GLE) fell 6% and 9%, respectively, while Credit Agricole SA (ACA) was up 6%. Germany's second-largest bank, Commerzbank AG (CBK), dropped 20% during the quarter, as it suffered a few broker downgrades, announced job cuts in an effort to improve earnings, and sold new shares to existing shareholders in order to raise funds to service loans and debts. Meanwhile, Deutsche Bank AG (DBK) was down over 6%.

Automakers turned in a mixed performance. German auto majors BMW AG (BMW) and Volkswagen (VOW) gave up 7.2% and 9.5%, respectively. Daimler AG (DAI) was up a marginal 2.5%. Peugeot SA was up 3.3% in Paris, while Renault SA (RNO) drove up 20%.

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