INVESTROR: July was another bad month for equities, falling by more than 10 per cent, with financials in particular taking a hit

July has proved to be another torrid month for equity markets as highlighted by the performance figures in the accompanying table. With no sign of any let up in bear market pressures over the early days of August, these figures make depressing reading.

The overall Irish equity market fell by more than 10 per cent in July, which was more or less in line with overseas equity markets. US markets did slightly better than this in July while European markets fared somewhat worse. For example the French market, as measured by the CAC-40, posted a return of -12.4 per cent for July.

Declines in share prices were broad based across virtually all sectors during the month. In Europe, the only sector to show positive returns over the month was telecoms as several of the major telecom stocks bounced off their year lows. Over the month France Telecom rose by 55 per cent, Deutsche Telekom climbed by 22 per cent while Vodafone was 11 per cent ahead. Other telecom stocks such as MMO2 (the owner of Esat), Telecom Italia Mobile, Sonera and Cable & Wireless all rose by 6-10 per cent during the month.

Unfortunately, these rises in July flatter to deceive in that the share prices of most telecom stocks are still well down so far this year.

Therefore, these gains are only rebounds from very oversold positions and it is most unlikely that they represent the beginning of a fundamental reappraisal of the sector.

One global sector that did particularly badly during July was the financial sector. Insurance companies fell across the board as investors worried that many companies could become forced sellers of equities to maintain their solvency ratios. Towards the end of the month, banking stocks were hit as several banks announced they had sharply increased their provisions for bad debts.

For those investors that have the bulk of their portfolio in the Irish equity market, this is particularly worrying. The financial sector now accounts for just under 50 per cent of the total Irish equity market, as measured by market capitalisation, and the sector has performed very well so far this year.

Despite a fall of 8.5 per cent in the ISEQ-Financial index in July, Irish financials are still in positive territory over the year to date. For example, Anglo-Irish Bancorp and First Active have risen by 45 per cent and 44 per cent respectively in the seven months to end-July. Bank of Ireland and Irish Life & Permanent have performed well, albeit less spectacularly, with rises of 11.3 per cent and 9.2 per cent respectively over the same period. Of the main quoted financial stocks, only AIB is showing a negative year-to-date return of -5.8 per cent .

The Irish financial sector has outperformed its international peers for a number of reasons. First and foremost, the booming Irish economy of recent years has generated extremely strong growth in the demand for loans. For example, the growth in mortgage finance over the past five years has been phenomenal. Growing loan books spell bigger profits for banks as long as there is not a commensurate rise in bad debts. In this regard, the experience of the Irish banks has been very good, as the booming economy combined with very low interest rates has meant very few loans have turned sour.

Another positive factor for the Irish banks is that they have not got heavily involved in overseas lending nor have they deviated into high-risk sectors.

For example, Abbey National in Britain has had to take huge losses in its portfolio of junk bonds. In contrast the Irish banks have, by and large, focused their activities on lower-risk lending to individuals and standard commercial projects. This more defensive mix of business should continue to provide support to the Irish financial sector in an increasingly uncertain economic and financial environment.

The key driver of Irish financials, however, will be whether the Irish economy can continue to sustain an above average rate of economic growth over the medium term. Despite evidence of a slowing pace of growth and intensifying worries about the public finances, the economy has continued to perform well so far this year.

Nevertheless, 2002 is shaping up to be a very difficult year for the Irish economy. If the economy does even reasonably well over the next two to three years, it is likely that Irish financials can continue to deliver competitive returns to shareholders. If the economy falters in a significant way, inevitably it will adversely affect the quoted Irish financial stocks.