View from City Road: UK shares to gain from turmoil

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The speed with which financial markets pushed firmly ahead yesterday revealed just how confident investors are about prospects in Europe.

The CAC-40 index in Paris continued its recent strong run, rising by 43.15 points, or 2 per cent, to 2,129.03, which more than offset a 1.5 per cent depreciation of the French franc against sterling on the day.

The French central bank left its key intervention rate unchanged but the slide in three-month eurofranc interest rates, down 1.5 per cent to 8 per cent, indicated the way money markets are thinking.

In Frankfurt the Dax index scored a gain of 11.85 points to 1,815.08. Not only do investors expect a currency profit on the mark but they also look forward to a steady reduction in German interest rates.

UK markets, with a 15.2-point rise in the FT-SE 100 to 2.941.7, joined in welcoming the new European currency landscape. Three-month eurosterling matched euromarks with a 0.0625-point fall to 5.8750 per cent.

Amid the generally positive tone there is clearly room for disappointment. Unlike sterling's dramatic ejection from the ERM last September, which provoked a 15 per cent devaluation at one point and tumbling domestic interest rates, the current ERM break-up has been widely anticipated by financial markets.

So it would be unwise to expect Continental equity markets to match the spectacular gains seen in London in the months following Black Wednesday. Continental markets are trading on very high valuations that already discount recovery in local economies next year.

Morgan Stanley calculates that the French market is on a prospective price-earnings ratio of 19 and the German market sells for 20.5 times earnings for 1994. Corporate profits in both countries are going through the mincer and there could be unpleasant shocks.

But the fact that Continental European interest rates are expected to fall by 3.5 to 4 percentage points in the next 12 months will make dividend yields in France and Germany relatively much more attractive, ensuring forward momentum.

The biggest beneficiary of all could be the UK market, which is on an upward cycle. Expect outperformance from the high-yielding, low-risk utilities, companies such as Hepworth with European but low German exposure, motor component makers and transport shares of the likes of BAA.