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The Dow and the ISEQ growing apart Back  
The traditional close correlation between the Dow and European stock markets, and the ISEQ in particular, has changed due to the advent of the euro writes Liam Boggan
Equity markets performance is composed and determined by a number of factors . These can be broken down into three broad categories. Macro Economic trends , Fundamental analysis and finally Technical Issues. The Macro environment is the broad environment in which markets operate. Fundamental analysis deals with company valuations and analysis of management strategy and balance sheet strength. Technical Issues concern all other factors such as sentiment and analysis of the other factors that will impact on markets but which are neither economic nor company specific.

There is and always has been quite a high degree of correlation between the ISEQ and the Dow. This correlation is driven by a number of factors . Many Irish quoted companies have significant exposure to the US market and thus the performance of the Dow can be taken as a leading indicator of the performance of the US economy and hence that proportion Irish corporate earnings . Earnings from the US account for approximately 19 % of the total earning of the Irish market . This is quite a high figure and can be used to explain some of the correlation between the two markets.

At the Macro economic level , If you look back over the past five years on a comparative basis you will see that both economies have been quite successful in achieving strong economic growth rates without any really worrying signs of overheating and the prospects for both economies looks positive for the immediate future.

Fundamental analysis reveals a wide divergence in the valuation of both markets. The US market is trading on a 1999 multiple of earnings of 24.1 times compared with a multiple for the Irish market of only 15.4 times. If you look at the forecast growth rates for both markets the Irish market also compares very favourably with that of its US counterpart. On this basis the Irish market is cheap and represents excellent value for long term investors.

There is a saying in the market that whenever the Dow catches a cold Europe gets the Flu . That is to say that European markets in general have been highly correlated in performance terms with Movements in the US equity market .This is explicable by the sheer size of the US equity market and the impact and importance of the health of the US economy on the world economy in general . This relationship has weakened recently for a number of purely technical reasons.

The first of these is the advent of Euroland and the consequent restructuring of pension fund portfolios by fund managers . In Ireland the traditional benchmark exposure of irish pension funds to the domestic market was approximately 30 % and now in a Euro environment this need not be the case. Indeed the debate is really only beginning as to what the new appropriate exposure level should be.

Pension fund trustees backed by actuarial consultants have been encouraging a large scale disinvestment from Irish equities into other Eurozone equities on the basis that it reduces the risk to that portfolio from an over reliance on one small economy. Portfolio diversification has been the prime feature of the irish market since the announcement that Ireland was definitely amongst the first group of nations to adopt the Euro as our currency.

The most immediate impact on the irish equity market was a collapse of share prices as the domestic institutions all attempted to sell shares in order to reduce their weightings. There was a profound impact on the valuations of the small and medium size companies in Ireland . Some share prices halved in the six months to the end of 1998 and indeed these are now trading on extremely attractive valuations despite the strong economic fundamentals. More recently the Institutions have been trying to reduce exposure to the larger companies whose shares are more internationally traded . As a result there is a continuous supply of stock on offer from Domestic institutions and this has hindered the performance of the Irish market .

The market situation in Ireland is mirrored almost identically across the rest of Europe . My colleagues in the Netherlands have just published their own piece of research on the small cap sector entitled 'Corporates buy , fund managers do not ' Their report shows that corporate activity is significantly increasing as valuations fall for reasons that have nothing to do with specific company fundamentals or prospects.

In contrast the US equity market is a completely different animal in terms of behaviour . The impact of the internet and the growth of online trading by large numbers of retail day traders has changed the landscape of the US market to the extent that in recent months institutional block trading has represented less than twenty percent of total trading in some of the large well known names. This is not a feature of the Irish market which tends to be institutionally dominated .

In conclusion , it has been and will continue to be possible to make general predictions about ISEQ movements by watching the Dow . However at this moment in time there are powerful technical forces at work which are ensuring that the correlation between the two markets is diminished and there is no sign that these technical issues will abate in the short term . In the meantime there is now an opportunity for the genuine long term investor to take a view and buy quality cheap Irish stocks at rock bottom valuations.

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