Stock Market Week: European big players face relegation in Dow Jones reshuffle

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The Independent Online
FUND MANAGERS and footballers normally have little in common but this week several stockpickers will experience a striker's worst nightmare: a move in the goalposts when he is about to shoot.

The only difference between market and football players lies in the nature of the moving target. Where soccer stars have goals, institutional investors have shares indices as the key benchmark against which their performance is judged. This week one of these crucial reference points will beoverhauled and many market players are crying foul.

On Thursday, Dow Jones, the US index provider, will announce a big shake- up in its Stoxx 50 and Euro Stoxx 50 - the indices covering the top 50 European and Eurozone blue-chips respectively. Under proposals announced a few months back, Dow Jones has decided to choose members of the two indices irrespective of their country of origin.

The change, to be implemented in September, means European countries will no longer be allowed a "quota" of companies in the index and selection will be down to market capitalisation and sector membership only. This will force institutions whose funds track the indices into an expensive reshuffle of their holdings and could cause shockwaves in the UK and continental equity markets as some 25bn euros (pounds 16.5bn) is invested in the Stoxx indices.

According to a study by Joaquim de Lima, head of derivatives research at HSBC Securities, the rules will have two major implications for European stock markets.

First, Eurozone countries such as Portugal and Ireland will cease to be represented in the Euro Stoxx as Portugal Telecom and Allied Irish Banks are set to drop out. The two are near the top of a list of relegation candidates which also includes Elsevier, the Holland-based arm of Anglo- Dutch publisher Reed Elsevier; the German airline Lufthansa; the Italian carmaker Fiat and French electrical goods maker Schneider.

They are set to be replaced by a host of French and German companies. Among the Teutonic potential entries, insurer Munich Re, chemical groups BASF and Hoechst, and bank Dresdner should get in. As for the Gallic presence, the drug company Sanofi-Synthelabo and the utility Suez Lyonnaise look ripe for inclusion, while the Spanish bank BSCH looks like the only non- French or German new arrival.

Dow Jones contends that a truly Eurozone index should disregard country factors, arguing that firms should get in the index on their own merits. But as Mr de Lima and others have shown, the less-than-perfect convergence of the European economies means that many continental stock markets are heavily influenced by local factors.

As a result, an index which leaves out some countries and gives a heavy weighting to others is bound to create problems for fund managers tracking Eurozone equities.

The second distortion is closer to home. The new rules means that the Stoxx 50 - which includes UK and Swiss equities alongside Eurozone stocks - is in danger of being dominated by British-listed companies.

For a start, the bulk of the new entries is made up of FTSE 100 blue chips. Telecom giant Vodafone Airtouch, the bank HSBC, the oil group Shell and the drug behemoth SmithKline Beecham should all get in. And even if a couple of UK biggies, such as Marks & Spencer and insurer Royal & Sun drop out, the huge market value of the new arrivals should boost the weight of UK-based stocks in the Stoxx.

This is not a problem in itself, as London is the biggest equity market in Europe. But the catch is that some of the companies set to join are not strictly European. HSBC, for example, derives over half of its profits from Hong Kong and the US, while nearly 60 per cent of SB's earnings come from the US, and their inclusion in the index is set to dilute its function as a real pan-European benchmark.

Overall, it is hard to disagree with claims that the Stoxx changes are in real dangers of turning the indices into a less credible and useful tool for fund managers.

Domestic stockpickers will this week have remarkably few results to get their teeth into. WPP is one of of only two blue chips due to report interims. The advertising and communication powerhouse is today expected to unveil a rise in profits to around pounds 105m from pounds 93.8m last year.

Profit growth has been underpinned by steadily increasing revenues in the States, where the company has won a batch of high-profile advertising accounts such as United Distillers, cable group NTL and computer giant IBM. Some experts expect an improving performance from emerging markets' operations following the upbeat statements by rivals Cordiant and Saatchi & Saatchi. The chief executive, Martin Sorrell, will also update analysts on WPP's margin-improvement programme and any progress along that route will be gratefully received by the market.

Growth targets will also be at the centre of Rentokil Initial's interims on Wednesday. After warning in May that the company will miss his mythical 20 per cent annual earnings growth this year, the chief executive Sir Clive Thompson will want to reassure the market that the pest control and cleaning giant is back on the growth track.

For now, however, Sir Clive, once famous as "Mr 20 per cent" will have to make do with his new tag of "Mr 10 per cent" as interims profits are set to rise by around that amount to pounds 252m. Poor sales in the property services and cleaning divisions will be at least partially offset by good growth in the security and distributions businesses.

The question uppermost in the market's mind is whether Sir Clive is planning to boost profits with another blockbuster deal similar to the mega takeover of rival BET or whether he wants to go for a share buyback. In the past few weeks, whispers of a strike at UK competitors Hays, or even Compass have been around.

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