Half-year highs

01 May 2008

European stock market indexes have had a good run in the first six months of the year. France's CAC 40 was up +9,67% between weeks 1 and 26, while the German Dax Composite put on +8,2% and the UK FTSE 100 gained +5,99%. This was all in stark contrast to the US markets, where the blue-chip Dow Jones Industrial Average lost -3,28%.

But even more impressive than the European indexes’ improvements were those seen in the construction sector. The CEE Index of equipment manufacturers was up +11,83%, the CEM Index for materials producers gained 12,3% and the CEC Index of leading contractors’ shares put on an impressive +21,72%. These translated to a +14,43% gain for the CET Index, which is a composite index of all three sectors.

Equipment

Although it saw the smallest gain of the three sectors, it is a little surprising that the equipment segment increased in value at all, given that it is so heavily weighted by the large US manufacturers. These were a mixed bag of results, with small players like Gehl and JLG enjoying the best gains, while large capitalisation companies like Caterpillar, Deere and Ingersoll-Rand were more mixed.

The picture was much more consistent, and indeed brighter, among the European manufacturers. Major players like Volvo, Atlas Copco and Metso all enjoyed double-digit improvements, although access platform specialist Pinguely-Haulotte was the pick of the bunch with a +95,88% gain. These results combined with mixed but generally positive developments for the Asian manufacturers to pull the CEE Index well into positive territory.

This general buoyancy seems to be indicative of both the on-going high demand for construction equipment around the world, and the much-improved profitability of the sector compared to recent years.

Materials producers have also enjoyed six months of strong gains. While economic buoyancy may have played its part, the clear driver in this sector has been mergers & acquisitions activity. Following Cemex's acquisition of RMC at the end of last year, Holcim acquired Aggregate Industries. Mid-June saw the launch of a € 60 per share bid by Spohn Cement, backed by German billionaire Adolph Merckle, to take Heidelberg Cement into private ownership.

This string of bids has had two effects. First, they have raised the share prices of the target companies to entice the existing shareholders to sell. Second, they tend to raise the share prices of other companies in the sector, in anticipation of further acquisitions.

Judging by share price rises and reported stock market gossip, this line of thinking would put Hanson next in line as an acquisition target. The issue with Hanson though is that it has a large number of on-going lawsuits in the US, relating to former employees’ exposure to asbestos. The problem is not so much that this might be an open-ended expense-Hanson currently estimates gross costs to be about US$ 60 million per year-it is more the uncertainty about costs, which is inherent due to the thousands of cases involved. This makes it difficult to determine a fair takeover bid price, and so is a deterrent.

Contractors

But while materials producers and equipment manufacturers may have done well, the share price gains for contractors have been sensational. The CEC Index for the sector was up +21,72% in the six months to the end of June, with almost every component company seeing double-digit gains.

Walter Bau was of course the most notable loser, and Impregilo's shares also slipped, although this is perhaps a little misleading as the company was in the middle of a recapitalisation process in week 26. Mowlem is going through a difficult patch with a string of profit warnings prompting some major restructuring.

Bouygues apparent loss has to be seen in the context of a one-off payment of € 5 per share made in week 2. Adding this on to the end share price would equate to a +11,4% gain over the half-year. Aside from these problems, it was good news all the way for the sector, with +20% to +40% share price rises not uncommon. Indeed, such was the demand for shares in the sector that there were three major share splits in the space of four weeks.

Currencies

Weeks 1 to 26 were a period of overall depreciation for the Euro. Most significantly, it lost -8,26% against the US Dollar to end up at €1 = US$ 1,21. There were also losses against the Pound, Yen and Won, along with many other European currencies, the only gains being seen against the Swiss Franc, Swedish Krona and Danish Krone.

The loss against the Dollar will be particularly welcome, although there is still a long way to go before the Euro reaches a level European exporters would be happy with-probably around one-to-one parity. However, the US Federal Reserve seems to be sticking by its policy of ‘little and often’interest rate rises, so the Dollar may continue to climb.

Outlook

The Dow has stalled so far this year due to the rising value of the Dollar, and the record cost of oil, which exceeded US$ 60 (€ 72) per barrel in June. The rising dollar/falling Euro is good for European exporters, so this may explain why European markets have done well this year, despite a much weaker economic picture than seen in the US. Oil prices affect both the EU and US, but their effects are more marked in the US because it is a bigger net importer of oil.

Oil prices, and commodity prices in general, are probably the biggest on-going negative factor for the stock markets, because the increases have been so sharp that it has been difficult for companies to pass these on to customers and maintain their margins. The markets are therefore looking for signs that these prices have peaked, and if such evidence emerges, it may give the Dow a healthy lift.

Europe on the other hand looks bright, with the on-going Dollar appreciation helping exporters. Any levelling of commodity prices will help the situation, so the outlook remains reasonably positive.

The loss against the Dollar will be particularly welcome, although there is still a long way to go before the Euro reaches a level European exporters would be happy with.

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