Currently 1 month volatility is up to 21.98% this is the highest since July of last year and it continues to trend upwards. As result, stock picking has become even more important.

Source: FactSet Estimates

The tides have turned. In contrast to 2006 where European profits ran around 15%, overall 2007 European profits have deteriorated quit swiftly to 5.8% growth. The main culprit is the energy sector which accounts for about 8% of the DJ Stoxx 600. The DJ Stoxx is an index often used to measure the European market. The energy sectors 2007 3-month analyst profit revisions are down -7%.

Valuation: European equities are gradually reverting back to their fair market value. Trading at 13.1x P/E which is about 2 points off its 10 year normalized average.

Market Context:

Something smells unusual in the market. For sometime in the market bond yields are slightly higher than dividend yields this is very unusual and indicates market aversion to risk. It is also indicative that long-term risk is no longer properly remunerated. For those of you who don’t know what Bond yields are they are simply the return received when a bond is purchased and held to maturity. On the other hand a dividend yield is the yield a company pays out to its shareholders in the form of dividends.

Conclusion:

A high degree of risk aversion after the TMT crisis has directly benefited yield stocks. Firms have cleaned up their balance sheets and look much healthier, however as inflation has come back into the lime light we are turning our view of yield stocks. Consequently from a sector standpoint in the near term we recommend defensives like pharmas and telecos where we believe now deregulation is priced in. On the opposite end we recommend to stay away from yield stocks including utilities, and property (financial services).

These views are independent of FactSet Europe Ltd and are proprietary to Bobby Rakhit. For the full report and individual sector reviews and recommendations please contact rakhitreport@yahoo.co.uk.