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Rebound in Europe? Don't Hold Your Breath

The second quarter may not be as volatile as the first for European markets, but it will be the timethe impact of the credit crunch on wider areas of the economy becomes clearer, traders and analysts told CNBC.com.

Stocks are likely to remain pressured, without repeating last year's stellar performances, as the battering taken by banks has taken its toll on the markets and more writedowns are expected.

Last year, Germany's DAX advanced by more than 22 percent, compared with Dow's rise of about 7 percent and a more modest performance of nearly 5 percent by the S&P 500 .

France's CAC40 soared by 10 percent between January and June, but lost momentum when the financial turmoil hit and ended the year only 2 percent higher.

"In the best case, these indices will move with the US markets but no further outperformance will be in play," Thomas Nagel, a trader at Equinet AG, told CNBC.com. "Indices like the FTSE-100 that moved the same way as the US markets have a chance for an outperformance."

"I am still bullish for stocks, as long as the key support levels are not being broken," Nagel added.

Banking Troubles

Societe Generale, which was forced to liquidate long positions in January after it accused one of its traders of fraudulently exceeding his limit ofexposure, contributed to wiping out the positive outlook for European indexes from the beginning of the year, Nagel said.

"This hard impact cancelled several years of outperformance within 48 hours," he added.

The DAX fell by 7.4 percent between Jan. 21 and Jan. 22, when the French bank unwound positions, the CAC-40 lost around 5 percent and the FTSE-100 lost nearly 3 percent.

If the Societe Generale episode was the most dramatic of the banking woes saga in the first quarter, it was by no means an isolated event. The other major European banks also sent shockwaves through markets when they announced losses and writedowns because of the credit crunch and exposure to the subprime crisis.

And there is no end in sight, analysts say.

"The second quarter will not be better for the banks than the first," Hans Engel, a stockanalyst at Erste Bank in Vienna told CNBC.com.

"They will need at least two, three, maybe four quarters for the problem to pass. It's a thing for a year, for sure," Engel said, adding that the main problem was the crisis of confidence, with banks still reluctant to lend to each other.

Writedowns will continue at big U.S. banks such as Citigroup or Merrill Lynch, and at European ones such as Deutsche Bank or Credit Suisse, he added.

Deutsche Bank spooked investors last week when it said in its annual report that it did not feel confident that it will meet its profit target if the credit crunch continued, a statement which was seen by markets as stopping short of issuing a profit warning.

Credit Suisse also said it was no longer sure it would post a profit in the first quarter after a handful of traders deliberately mispriced CDO debt derivatives, causing $2.85 billion in credit writedowns.

Earlier this year, UBS became the biggest European victim of the credit crunch with $18 billion in subprime-related writedowns.

Small and medium-size banks which sought to expand into emerging markets and avoided the financial innovations related to the U.S. market are the ticket for those seeking to buy financial stocks, Engel said.

New Gold Rush

New Gold Rush

But those looking for a sure return should still consider gold, despite the fall in commodities prices before Easter, Engel recommended.

"That's volatility. It was not surprising that at $1,000 the market would stop a little and sell," Engel, who predicts that the price of gold will double in two years, said. "It's a new gold rush, and it will accelerate."

Negative real interest rates in the U.S. and increasing demand for the precious metal from emerging economies such as China, India and Russia, will also push prices up, and stocks of major gold producers will do well, he said.

Another factor favoring rises in the price of gold and other commodities in the coming quarter will be the dollar, which will continue to weaken as the Federal Reserve stays on its easing path to save economic growth.

The single European currency is the best bet for currency players in the coming quarter, because the European Central Bank is adamantly sticking to its inflation-fighting mission, analysts said.

But if it exceeds a certain level, it may trigger fresh calls foreven actualintervention from the European Central Bank.

"I think at $1.60 we'll see politicians making some noise," Paul Bednarczyk, currency strategist at 4Cast said. "I think if we go close to $1.65, you might see some chance of intervention. The ECB might take some action."

The sterling, which lost more than 5 percent against the euro during the first quarter and more than 15 percent during the past year, is unlikely to sink further, Bednarczyk said.

"I think the sterling weakness (against the euro) is a bit overdone, especially with the interest rates we have," he added.

While the Bank of England may cut rates again to cushion the impact of the credit crunch on the real economy, the ECB is unlikely to ease monetary policy as long as the euro-zone economy is still going strong.

Economy Slowing Down

There are already signs of economic fatigue in Europe, said Martin van Vliet, euro zone economist, ING Bank.

"If you look at the industrial sector, confidence measures appear to be holding up quite well," van Vliet said. "But if you look at the services sector, you see a decline in confidence and activity. We think the upturn in the first quarter will not be sustained in the second quarter."

Strong demand in Eastern Europe, China and India has offset so-far slowing demand from the US and UK, but these countries will start to feel the pinch too.

This, coupled with a delay in the transmission of the strong euro effects and less investment because of the credit crunch, will bite into economic growth, analysts predict.

The end of the confidence crisis is nowhere in sight and there is already talk that authorities' actions do more harm than good, by not allowing the system to clean itself and thus preventing investors from believing in the market forces.

"Market players should know it's their risk, not the risk of the taxpayer," Engel said. "There must be one or two situations of bankruptcy. Otherwise, the hot potato gets passed from one of these companies to another."