If pundits are right, 2005 should be a good year for the Athens Stock Exchange and a bad year for government bonds, underpinned by a widely expected slowdown in economic activity. But pundits are not always right as the outperformance of Greek equities vis-a-vis their European peers and the triumph of the contrarian view on bonds proved this year. What then can we expect in 2005? We opt for a milder version of consensus thinking on equities and a more uneven economic growth scenario, of worse-than-expected GDP expansion in the first half and a pickup in the second half. Although Greece is expected to beat average GDP growth in the eurozone – widely seen as between 1.8 and 2.0 percent – extending its streak of outperforming its EU peers for the ninth consecutive year, it is reasonable to expect the distance will narrow as the Greek GDP is projected to expand by around 2.8-3.5 percent. This, in turn, spells bad news for efforts to bring the budget deficit below 3.0 percent of GDP in 2005. Of course, Greece may be lucky and avoid being singled out for not living up to its promises. That would lead to tougher supervision rules by the EU, unless the current Growth and Stability Pact, once dubbed «stupidity pact» by the former head of the EU Commission Romano Prodi, is revised. In that case, pressure on Greece to put its public finances in order may subside, giving the Greek side more leeway and time to implement its economic policy of «mild adjustment.» Whatever the outcome of deliberations at the EU level about the possible revision of the pact, Greece may have to lower its growth expectations to take into account the grim reality of certain corporate sectors, namely construction, textiles, apparel and clothing as well as their suppliers. Although some other sectors, such as shipping and banking, are thriving, the specter of bankruptcies of many small and medium-sized companies in those sectors is looming. Promises by the state to speed up payments to some construction firms for public works completed earlier in 2004 may alleviate the existing liquidity squeeze but is unlikely to keep a good number of them afloat. In addition, construction firms, small and large, complain of delays in auctioning new public works and accession projects, pulling down their backlogs. Uncertainties An expected healthy rise in incomes is likely to keep household consumption spending going but may not provide the kind of boost envisaged earlier if labor market conditions deteriorate and the external sector, namely exports of goods and services, does not come in strong. Many hopes for a pickup in economic activity in the second half of the year rest on a strong showing by tourist receipts and a recovery of investment spending as corporate tax cuts and favorable terms under the new development law have an effect on the real economy. Even so, it will take more to create a more favorable business environment, leading to stronger economic growth in the second half: perhaps a number of meaningful corporate deals, including privatizations, and the implementation of construction and information society projects, cofinanced in some cases with EU money. Europe sets the tone How should the Athens bourse perform in this economic environment next year? Broadly in line with the other European bourses is the most likely answer, meaning registering gains in the order of 9.0 to 15 percent without taking into account the positive impact of reinvested dividends. The example of the Vienna bourse, which has performed superbly following the right-wing government’s commitment to corporate tax cuts of 10 percentage points effective in 2005 after its election in March 2003, has given hope to many market participants that Athens can follow in its footsteps. It should be remembered that the Greek government is committed to slashing 10 points off the 35 percent corporate tax rate in a three-year period, starting 2005. This has prompted many analysts to revise upward their EPS (earnings per share) forecasts of major local listings, resulting in more attractive valuations. Although local firms can benefit from the announced tax cuts, it is corporate profitability, valuation comparisons, international liquidity conditions and the performance of the major European bourses which will set the tone. Whatever the outcome, it will take a favorable combination of all above factors for the index MSCI-Greece, widely followed by foreign institutional portfolios, to repeat last year’s and this year’s performance. With less than a week to go, the MSCI-Greece stock index records gains of 28.7 percent year-to-December 24, ranking third among all developed markets behind Austria’s 56.1 percent and Belgium’s 29.67 percent. MSCI-Greece returned 35.8 percent in 2003, ranking second behind Norway’s 38.1 percent. A big unknown is the impact of the introduction of IFRS (International Financial Reporting Standards) on financial statements and balance sheets which may unearth some skeletons. Already, the introduction of IFRS has provided a good excuse for major Greek banks to seek covert state aid to do away with a large chunk of their unfunded pension liabilities despite the fact that some private banks should not be entitled to such aid at all. Still, provided Emporiki Bank, and to a lesser extent Alpha Bank, come up with a solution to the pension issue and all banks confirm or beat market expectations on earnings, the market should feel more confident about extending its forecasts into 2007. In this case, a pickup of 10 to 20 percent should be on the cards for most heavyweight bank stocks, giving a lift to the general market. Assuming foreign flows continue to dominate trading on the Athens bourse, some other major stocks slated for part-flotation, such as Public Power Corporation (PPC) and lottery operator OPAP, should also perform well, assuming no disruption of specific plans. The big wild card is telecoms operator OTE, which may turn out to be the heavyweight stock of the year if restructuring proceeds and a major foreign strategic investor is found. Its mobile subsidiary CosmOTE should also benefit in this case as the chances of a merger with the parent company are enhanced. Nevertheless, the pleasant stock surprises may come from less well-known, mid-sized firms, such as Mytilineos, which is in talks to buy listed Aluminium of Greece from Canadian industrial powerhouse Alcan, and others able to show up in the radar screen of foreign funds. There are already signs that foreign funds have enlarged their menu of local mid-cap listed firms, such as Fourlis, Sarantis, Jumbo, etc. Given the Greek investment public’s tendency to go for smaller stocks, these and others may benefit even more if the local retail investors return to the bourse. All in all, 2005 should be another year of economic growth for the Greek economy, though uneven and closer to 3.0 percent, with Greek equities expected to produce a positive return in high single digits and even double digits in some cases. This assumes ample international liquidity, no economic recession in Euroland, no big unpleasant surprises from the introduction of the IFRS and a generally benign political and macroeconomic environment locally, with no restrictive fiscal measures.