Eurozone fiscal woes give FTSE advantage over DAX

In a slipping European equity market, the FTSE 100 looks set to suffer less than Germany's DAX and other top regional indexes, given its defensive characteristics and the eurozone's fiscal problems.

The UK index has fared better than its major rivals in the continent this year, and its relatively higher exposure to defensive sectors such as drugs, tobacco and food and to companies with dollar income will support more outperformance.

Although a strong dollar would also aid German's exporters on the DAX, any offer from Berlin to provide monetary help to Greece and other peripheral eurozone countries would weigh on that country's index, analysts said.

And while Britain is also grappling with a mountain of debt, it has the flexibility to let sterling fall to boost exports and cut imports, while high debt eurozone countries will have to rely on the European Central Bank to set monetary policy.

Even if a weak currency devalues UK assets, investors are likely to opt for the relative safety of the FTSE 100, though they may have to switch to euro zone laggards once Greece's fiscal problems are on the road to resolution.

"For its defensive characteristics and its dollar sensitivity, the UK is in a reasonable place compared to the other areas in Europe and obviously the peripheral countries that are going through their fiscal problems," said Graham Secker, equity strategist at Morgan Stanley.

"The dollar is going to continue to strengthen, and the UK stock market is a big player on the dollar because of the oil sector, the pharmaceutical sector and a large number of overseas companies."

Sterling has lost 2.1 per cent against the dollar this year as investors opted for the more liquid US currency in times of uncertainty, but is up 1.7 per cent against the euro.

Last week, one-third of the FTSE 100, adjusted for weighting, was made up of stocks traditionally regarded as defensive - pharmaceuticals and healthcare, telecommunications, beverage and food producers, tobacco and utilities.

On the other hand, pharmaceuticals, telecoms, utilities represented about 24 per cent of the DAX on the same basis, while they represented 30 per cent of France's CAC 40.

Morgan Stanley recommended going long on DAX volatility and short on FTSE volatility, expecting the Germany's blue chip index to underperform. Volatility tends to rise when the underlying market falls. The FTSE 100 has lost 2.5 per cent this year, compared with DAX's 5.3 per cent fall, CAC 40's 5.7 per cent drop and Spanish IBEX 35's 12 per cent slide.

Analysts also said the UK's flexible economy and its freedom to set monetary policy have helped the FTSE 100 performance.

"Domestically, the economy is more flexible and that flexibility is helping the UK. You can see the problems in the eurozone fringe economies. They haven't got that exchange rate flexibility or that interest rate flexibility that the UK has," said Robert Parkes, equity strategist at HSBC.

Bank of England Governor Mervyn King said last week the central bank may have to pump more money into the economy.

Athens would have to implement tough austerity measures, including more budget cuts or higher taxes, or both, to put its house in order, when its economy was still in recession in the last quarter of 2009.

In the coming months, Greece faces two major hurdles with two lots of more than €8 billion of government bonds to refinance in April and in May.

Robert Quinn, European strategist at Standard & Poor's equity research, said the FTSE 100 may offer investors a shelter for now, but once Greece's refinancing issue has been resolved investors would have to switch out of the UK index quickly.

"Greece has an amortising schedule that is quite heavy come the end of April. Until that has been cleared up, it might weigh heavily on the market," Mr Quinn said.

"In the meantime, you could say that the FTSE 100 is the better place to park. Once this overhang is cleared come May, the other equity markets are going to be the place to be and in that case you may want to reverse the trade."

In terms of valuations, the UK index is cheaper than top European rivals with the exception of the Spanish index, which has been hit hard on fears over its sovereign credit even though its deficit and debt problems are not as pronounced as Greece. The FTSE 100 has a one-year forward price-to-earnings of 11.3, compared with DAX's 11.8, CAC 40's 11.5 and IBEX 35's 10.3. For now, the UK benchmark offered investors a shelter when Germany's economic recovery stalled in the last quarter of 2009 and German investor morale dipped in February.

"The DAX could be exposed to heightened risk given that Germany's offer to provide liquidity assistance to Greece comes at a time when its own GDP growth recovery looks fragile as indicated by recent very weak industrial production numbers," Morgan Stanley said.