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EUROPE IS THE BRIGHT SPOT IN WORLD MARKETSFalling rates and lively economies make the region look like a haven in the stormGlobal equity investors are facing an awkward dilemma as summer begins. Anything that looks attractive is expensive. And anything that looks cheap is unattractive--and for good reason. The stakes are high. Share prices in the U.S. and Europe have more than doubled since 1995. So an oversize stake in one country or sector could have dire consequences if malaise sets in. Still, most experts believe that the best markets will be outside Wall Street, despite its long record of strong growth. The Standard & Poor's 500-stock index trades currently at a lofty 21 times expected 1998 earnings, which show weak growth. In contrast, many emerging markets are selling at fire-sale prices. But beware: If the yen plummets and Asian markets fall further, emerging markets everywhere will get a drubbing. Despite their high valuations (table), European markets offer the best potential for further, sustainable gains. Economies of the 11 members of the European Monetary Union (EMU) are expected to grow 3% in 1998. With no inflation, interest rates are headed lower, too. So strategists recommend switching from the U.S. and Pacific Basin into Europe. ''Between now and the end of 2000, European markets will show total returns of 50% to 70%,'' says Credit Suisse First Boston's European strategist Francois Langlade-Demoyen. Investors, the strategists say, should redeploy assets to exploit a few global themes. Restructuring, consolidation, and shareholder value are old ideas in the U.S. But they are beginning to catch on elsewhere. Already, Europe is starting to reap the benefits of corporate restructuring, while recession-ridden Japan may be forced to follow suit soon. WHO DELIVERS? Investors can also benefit from sectoral trends in global markets. Technology, health-care, and pharmaceutical stocks are trading at steep premiums after a long rise. So Baring Asset Management Director Michael Hughes suggests focusing on companies that use, rather than provide, technology. Likely candidates are delivery companies such as Federal Express Corp. (FDX), mail-order companies, and banks, which can use the Internet to market services directly. Of course, there are dangers. With the imminent launch of the euro and the weakening of Asian currencies, investors need to consider currency exposure more than before. The yen could drop to 155 to the dollar, from about 139 now, because of Japan's weak economy and lack of sufficient fiscal stimulus, says J.P. Morgan & Co. global currency chief Avinash Persaud. So dollar-based investors should seek mutual funds that hedge currency risk when buying into Japan. The ruble, too, is a white-knuckle ride. Unless Russia gets outside help, it may have to devalue. That would further depress the Russian stock market, which has lost 51% so far this year, and other emerging markets. LOW RATES. Russia also highlights a less obvious trap for the unwary. After a gain of 98% in 1997, the Russian market got whacked when petroleum prices tumbled because it is dominated by oil companies such as Lukos and Tatneft whose export earnings are suffering. South Africa, New Zealand, Canada, and Chile present similar risks, however good their domestic commodity-based economies look, warns Persaud. But Europe is high on most stockpickers' lists because political and economic risks are low. Consider the fundamentals. Interest rates are down ahead of the euro's introduction on Jan. 1. Long-term rates for EMU members should remain around 5%, cutting the cost of capital to companies dramatically. Simultaneously, European companies have pared costs and improved the return they earn on capital, says Goldman, Sachs International Managing Director Jeffrey M. Weingarten. The main beneficiaries of cheap capital are Italy, Ireland, Spain, and Portugal. Until recently, they all had double-digit bond yields. Having cashed in gains as the yields tumbled, local investors moved aggressively into stocks. Phenomenal returns in the past 12 months, especially in Spain and Italy, have driven market multiples close to U.S. levels, says Jeffrey West, senior economist with London research firm IDEA. Spanish pizza delivery chain Telepizza Co., for example, soared 1,000% in local currency last year and now trades at 89 times estimated 1998 earnings. But value investors such as Colin Mclatchie of London's PanAgora Asset Management Ltd. expect further positive earnings surprises in Spain and Italy. He likes Spanish publisher Grupo Anaya, which has already doubled this year. Moreover, new stock indexes are pushing investors to hunt for stocks throughout the euro zone. Goldman, Sachs & Co. analyst Isabelle Hayen is bullish on Spanish and Portuguese utilities, including highflier Electricidade de Portugal (EDP), which is up 36% so far this year. Faster growth will put more money in European consumers' pockets. So equity strategists at both CSFB and Goldman Sachs are extremely bullish on sectors such as retail, construction, and telecommunications. Picks include stocks such as supermarket chains Carrefour of France and Ahold (AHO) of Holland, Telecom Italia (TI), and consumer-products giants Groupe Danone (DA), Nestle (NSRGY), and Unilever (UL) (table). SCARY ASIA. European restructuring is likely to boost mergers and acquisitions, share buybacks, and spin-offs, particularly in Germany and the Netherlands. The trend isn't yet fully priced into today's market, says CSFB's Langlade-Demoyen. So fund managers are eyeing deal-hungry companies such as ING Barings, the Dutch banking and insurance group, as well as Dutch bank, ABN Amro (AAN), and Zurich Insurance Co. Britain, meanwhile, with a slowing economy, is out of step with Europe. It's also staying out of the euro. But it still offers some buys. IDEA's West favors exporters such as British Steel (BST) that will benefit as the pound weakens, as well as Siebe, an engineering company that has pushed into Eastern Europe. In contrast, Asia scares off all but the most battle-hardened investors. To vulture investors like Bernard Horn, president of Boston's Polaris Capital Management, however, the market carnage spells opportunity. He likes Total Access Communication, the second-largest cell-phone provider in Thailand. On a visit, he discovered it is gaining customers, mostly Thai farmers who can afford the service as their crops are priced in dollars. Indeed, Thailand may offer the best opportunities in Southeast Asia because it is implementing economic reforms. Gary L. Greenberg, managing director at Van Eck Global Asset Management (Asia) Ltd. likes life insurer Ayudha Jardine CMG Life Assurance, which has fallen by 82%. He figures the low price and the company's local franchise make it a strong buy. Despite troubled banks, corrupt politicians, and a worsening economy, Japan may also be too cheap to bypass entirely--if you have a strong stomach. Four out of 10 issues in the Nikkei index now cost less than their net cash holdings, says Barings' Hughes. Even so, he recommends holding only a small percentage of Japanese equities until the government acts to jump-start the economy and corporations start the massive restructuring they need. Says Hughes: ''Japan is too big to ignore but too dangerous to be fully invested in yet.'' Goldman's Weingarten has reduced the number of Japanese stocks on his buy list in the past eight months. But he still likes Nippon Telegraph & Telephone Corp. (NTT), which has undervalued assets such as its cell-phone division, NTT DoCoMo. Asia's woes have sloshed over to Latin America. Mexico's Bolsa de Valores is down 23% in dollar terms this year, while Brazil is down 6% and Argentina 13%. Corporate earnings have been hit by tighter monetary and fiscal policies to counter the Asian shock and lower commodity prices. Elections in Brazil this year, Argentina next year, and Mexico in 2000 are making investors queasy. Redemptions of Latin mutual funds are running at about $50 million a week, says Ian Laming, a strategist at Robert Fleming Inc. in New York. GROWTH SPURT. The exodus may be premature. Mexico's economy is set to grow almost 5% this year, and Argentina may reach 6%. Even Brazil, with lackluster 1.5% growth in prospect, could produce some surprises. Companies there are slashing costs and paying down debts. As a result, Laming estimates, Brazilian companies' cash flow will rise 23% this year. Peter Jarvis, manager of Invesco's Latin American Growth Fund, is another Brazil bull. The country's stock market trades at nine times 1998 earnings, though corporate earnings are set to grow at a 15% lick or better this year and next. ''It's the only place in Latin America where you can see real momentum for change,'' says Jarvis. One long-awaited change is the sale of the government's remaining stake in Brazilian telephone company Telebras later this year. James W. Barrineau, Latin equity strategist for Salomon Smith Barney in New York, makes Telebras (TBR) a top pick because it is so cheap. ''It's a long-term value play that's really undervalued,'' he says. Fleming's Laming also likes Telebras' regional subsidiaries Telerj and Telemig, while Deutsche Morgan Grenfell prefers the Sao Paulo subsidiary Telesp. Rising real wages this year are driving a spending spree in Mexico. Companies likely to benefit from the surge in consumption, says Barrineau, include TV Azteca (TZA) --Mexico's No.2 media company--and retail chain Elektra (EKT), which sells on credit to working-class families. Both have recently lagged the market. Telecommunications companies remain staple fare in most investors' Latin American portfolios. Deutsche Morgan Grenfell recommends Telefonos de Mexico (TFONY). Despite its recent slide--its American depositary receipts are down 17% this year--the company is profitable. Laming, too, likes telecoms, particularly the exploding cellular business in Argentina. His pick: Telecom Argentina (TEO), which he expects to grow 25% this year. Savvy investors can find plenty of global gems worth buying out there. All the same, they need to exercise some caution: Global markets are still digesting the roller-coaster events of 1997, so any new economic or political shocks could give world markets a hard punch. The best way investors can protect portfolios against a knockout blow is by employing a bit of defensive diversification.
By Kerry Capell in London, with Elisabeth Malkin in Mexico City and Mark Clifford in Hong Kong RELATED ITEMS
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Updated June 4, 1998 by bwwebmaster
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