Europe’s Markets Still Lure U.S. Pros
Given the alternatives of a still-floundering Japanese stock market and a possibly overextended American one, many investment pros say that on the whole they’d rather be in Europe again this year.
Among the world’s largest equity markets, Europe’s-- which mostly generated strong returns in the fourth quarter and in 1998 overall --present a good case for another year of outperformance, according to these experts.
They continue to list reasons recited all year yet still valid, of which the 11-nation European economic and monetary union launched Friday is only the best-publicized:
* Europe lags the United States by several years in corporate streamlining and consolidation. Thus, there are far more benefits remaining for shareholders to reap from cost-cutting and merger-and -acquisition activity.
Moreover, deregulation and the privatization of historically government-run enterprises --not big factors in the U.S. in recent years --still have plenty of room to run in Europe.
* Similarly, European companies are only beginning to acquire the kind of “shareholders first” attitude that has been drummed into corporate America over the last decade and has been cited as a big reason for the long U.S. bull run.
* Stock buybacks, long a minor factor in European markets, may explode in 1999 as countries pass enabling legislation and tax changes. Strategist Richard Davidson of Morgan Stanley Dean Witter predicts buybacks could double to $50 billion this year.
* The demographic trends that have helped feed Wall Street’s bull are gaining momentum in Europe, whose population is moderately younger but whose private-pension system is vastly less developed than its U.S. counterpart.
* Interest rates, already lower than U.S. rates, should continue to spur economic growth and help keep sky-high consumer confidence up. Some observers expect the new European Central Bank to cut short-term rates even further.
Low rates on fixed-income investments, along with a zeal to boost retirement savings, should keep the torrent of cash flowing into European equity mutual funds above even 1998’s record levels.
Europe’s economic and monetary union, more than a decade in the planning and now finally ready for prime time, will have profound effects on the continental markets, analysts say.
“It’s much more than just a currency convergence,” said David Lui, manager of the Strong International stock fund in Milwaukee.
By requiring all 11 participating countries to meet strict annual guidelines for budget deficits, inflation and accumulated government debt, economic and monetary union (EMU) functions like a multinational balanced-budget amendment, Lui said.
Best Performers Will Stand Out
Removing currency differences also makes for easier comparisons across borders and across industries. This should make the best performers among companies stand out even more sharply. But it also may hurt stocks that have sold at a premium not for any business reason, but merely because of an investor preference for shares denominated in Italian lire or Dutch guilders, for example.
David Bowers, London-based senior strategist for Merrill Lynch, said the “single, deep, liquid capital market” created by EMU will pull corporate Europe away from its traditional reliance on commercial bank financing.
But along with cheaper and more flexible financing comes “increased pressure for improved earnings, more transparency and better corporate governance,” Bowers noted.
Europe, in other words, may be importing the Wall Street culture in which companies routinely get beaten up in the markets for missing a quarterly earnings target.
Another result of the switch to a capital-markets orientation may be the issuance of a wider range of tradable corporate debt instruments, said Kermit L. Schoenholtz, chief economist of brokerage Salomon Smith Barney in London, in a recent speech to the Royal Institute of International Affairs. The European corporate bond market is currently far smaller and less liquid than its American cousin.
While a deeper bond market could lure some Euroland investors from stocks, Schoenholtz nevertheless believes that stocks will outperform bonds in Europe in 1999, whereas he expects the reverse will be true in the United States and Japan.
Most experts concede that strong European stock markets --and indeed, a healthy European economy --depend most critically on a continued U.S. economic expansion. “If the U.S. slows down too much, the whole world will slump,” Lui said.
That said, Lui retains an optimistic outlook on European stocks, saying he would not be surprised to see another year of 20%-plus returns, with telecommunications and finance among the best sectors.
He and other pros acknowledged that in Europe, just as in the United States, stock valuations are historically high.
Because of tax differences, it isn’t easy to compare European price-to-earnings ratios with U.S. ones, but on a price-to-cash-flow basis their valuations are comparable --and thus equally vulnerable to earnings disappointments.
Among Lui’s top individual stock picks are Dixons Group, a British consumer electronics retailer that has turned itself into an Internet play by teaming up with a start-up telephone company to become Britain’s biggest Internet service provider --bigger even than British Telecom. At about 21 times 1998 earnings, it is relatively cheap, especially for an Internet stock, he said.
In France, Lui likes STMicroelectronics (“the Intel of France”) and Banque National de Paris, because it has a strong domestic banking franchise and has been battered --excessively, he thinks --for its Latin American and Asian loan exposure.
Another Lui favorite is Finland’s Nokia Corp., which is becoming increasingly well-known in America for its cellular phones. Lui compares it to Dell Computer Corp. for the way it used quality products and marketing savvy to knock off an entrenched market leader --Motorola Inc., in Nokia’s case.
Pressure to Remove ‘Structural Rigidities’
Clarkson Williams, international equity analyst for Pioneer Group in Boston, whose mutual funds include Pioneer Europe, World Equity and International Growth, believes that investors in Europe will benefit from increasing pressure to remove “structural rigidities” in the labor markets there.
Williams also believes that large -capitalization stocks will continue to outperform smaller -company stocks, and he is cautious enough about the European economy to recommend stocks with “defensive earnings,” such as pharmaceuticals and telecom firms.
Unilever Corp., for example, the huge Anglo-Dutch purveyor of food and personal -care products, is attractive because demand for its goods tends to be recession-resistant, he said. In the tech sector, Clarkson prefers service providers to hardware or software sellers and lists as a favorite the Dutch computer -services firm Getronics.
The services theme also leads him to Vivendi, the French industrial-service group that manages energy, waste-management and water -distribution systems.
Finally, what about currency risk for U.S. investors in Europe? As always, it’s a trade-off: The new Euro currency, if strong versus the dollar, would automatically boost U.S. investors’ returns in Euroland stocks. But a too-strong Euro could depress Euroland exports and thus the economies.
Rather than try to predict currency swings, many pros simply focus on stocks’ fundamentals for the long haul.
Thomas S. Mulligan can be reached by e-mail at thomas.mulligan@latimes.com.
* MORNINGSTAR RATINGS
Top European stock funds. C14
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How European Stocks Fared
European stocks rebounded sharply in the fourth quarter with other world markets, and for the year most Euroland markets generated higher returns, in dollar terms, than the U.S. market-thanks in part to strengthening Euro currencies earlier in the year. How key markets fared in native currencies and in dollar terms:
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4th-quarter change 1998 change Market/index Native U.S. $ Native U.S. $ Greece/ASE +34.1% +35.6% +85.0% +86.2% Finland/HEX Gen. +40.6 +38.4 +68.5 +79.8 Belgium/BEL-20 +24.2 +22.7 +45.3 +56.4 Italy/MIB-30 +32.9 +31.3 +40.9 +50.5 Spain/IBEX-35 +37.9 +35.9 +35.6 +44.8 France/CAC-40 +29.8 +27.8 +31.5 +41.0 Portugal/BVL Genl. +30.2 +28.7 +26.2 +35.5 Ireland/Overall +21.5 +19.5 +23.2 +28.6 Netherlands/CBS Gen. +25.0 +23.8 +22.3 +31.9 Germany/DAX-30 +18.4 +17.1 +17.7 +26.9 Sweden/OMX +24.1 +20.5 +16.9 +14.6 Britain/FTSE-100 +19.9 +16.7 +14.6 +15.4 Switzerland/MI +30.5 +29.1 +14.3 +21.3 Denmark/KFX +15.5 +13.9 +4.2 +12.1 Norway/OBX Total +6.2 +3.8 -26.7 -28.5 U.S./S&P; 500 +24.6 +26.7
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Source: Bloomberg News
