The Greek economy may feel the pinch of the global economic slowdown in the second half but will most likely manage to grow at an annual rate of 3.8 percent or better this year and the next. Although this should have been a good reason for the Athens bourse to outperform other European bourses, statistics show this is not the case. Being a small market may not help at present, but the Athens bourse’s biggest hurdle seems to be negative domestic sentiment and lack of earnings visibility. Based on the most recent data, the MSCI-Greece index, which comprises 24 leading local listed companies, lost 39.50 percent from the beginning of the year to September 20. The same index lost 22.93 percent in the course of the last four weeks to September 20. During the same period, the MSCI-Germany index was down 40.28 percent and 25.99 percent while the MSCI-France index retreated 34.92 percent and 19.27 percent respectively. Among smaller developed European markets, the MSCI-Portugal index had lost 29.67 percent and 9.79 percent respectively and the MSCI-Austria national index was down a mere 2.77 percent year-to-September 20 and 9.08 percent in the last month. Among broader indices, MSCI-EAFE was down 29.54 percent and 15.69 percent respectively while the MSCI-Europe index had lost 32.64 percent and 18.25 percent. On looking at relative performance, it is easy to point out that Athens tracks the big continental European stock markets, namely Germany and France, and pays less attention to smaller markets even though the latter have more in common with the Greek bourse. In addition, the Athens bourse has been harder hit than other European and world markets in the last month or so, and has shown greater sensitivity to the economic fallout from the terrorist attacks on the United States. This kind of behavior could be justified if the Greek stock market traded at a premium against other bourses on multiples such as the price-to-earnings ratio, commonly known as P/E, but this is not so. Indeed, data show the MSCI-Greece index traded at a discount versus the other European markets, small and large, as well as the broad MSCI indexes based on estimated 2001 and 2002 price-to-earnings ratios as of Friday. In addition to that, it offers the largest annual dividend yield at 3.8 percent in 2001 and 4.3 percent in 2002. For comparison purposes, the German stock market comes second at an estimated 3.3 percent dividend yield this year and 3.5 percent next. Following a steep decline which has lasted more than two years, the Greek market seems to be both oversold and undervalued at this point but still unable to capitalize on the projected strong growth rates of the Greek economy this year and next. Entering the league of developed stock markets on June 1, the Athens bourse has not been on the radar screens of foreign active institutional investors, which has deprived it of badly needed inflows at a time when local investors are refusing to invest. The lack of fresh liquidity has hurt sentiment even more, leading to even greater risk aversion on the part of local investors, who seem to be paying closer attention to the performance of major European bourses lately. So, it is not strange that the Athens bourse has behaved more or less like the major European stock markets in the last couple of weeks following the latest terrorist attack on the USA. Being a small stock market is not the best of things at times of increased equity risk premium and deteriorating economic prospects as foreign institutional portfolios flock to large markets for safety reasons. The fact that this has not stopped other small European markets from outperforming large US and European markets means the failure of the Athens bourse to capitalize on the local economy’s projected strong growth rates is due to other reasons. A lack of fresh funds flowing into the market and attendant poor sentiment may be two of them. However, doubts about the ability of many heavyweight stocks, such as banks, to generate satisfactory earnings growth in the next few years seems to undermine the Athens bourse’s cause for out-performance. To the extent that economic growth rates are projected to be slowing but remaining strong in 2001 and 2002, poor earnings visibility should be mainly attributed to doubts about the local firms’ ability to cut costs and boost their earnings and stock prices. Although the composition of costs differs among listed firms, it is known that banks are among large-caps facing the biggest challenge on the cost front in the years ahead. Their ability to reduce or contain costs while at the same time investing more in expanding facilities, information technology, training and hiring highly skilled, well-paid individuals will determine the outcome. The heavily oversold Athens bourse may stage an out-performance rally at some point in the remainder of the year. However, it will not be sustainable unless the current international environment of rising risk aversion is reversed and local firms effectively address the cost side of their business to remove the cloud from their earnings projections.