EUROPE'S CONTINENTAL DIVIDE Political pressures and low growth vie with expanded markets and merger mania After two years of booming European stock markets, the going has suddenly gotten rougher. Investors got a sharp reminder about risk when stocks sank 30% last summer. The market has since recovered sharply, but most pros think that, with a slowdown looming, risks have greatly increased. ''Confidence is going down,'' says Gary Dugan, European equity strategist at J.P. Morgan Securities Ltd. in London. ''The gap between the economies and the markets is widening.'' So the launch of the euro on Jan. 1 won't occur in the balmy environment anticipated a year ago. Gross domestic product will grow a modest 1.7% in the 11-nation euro zone, says Dugan. And most economists expect Germany, Europe's economic engine, to lag behind its neighbors, while Britain, the major holdout against joining the single currency, will flirt with recession. A slowdown could depress European profit growth to near zero, compared with an estimated 8% to 10% in 1998. There's also a rise in the ''politics of economic nonsense,'' as James Lister-Cheese of London-based Independent Strategy calls it. Europe's center-left governments are howling for more jobs yet won't pursue policies, such as liberalizing labor rules or slashing taxes, that might create them. Dugan, one of Europe's more bearish analysts, expects this will result in a paltry 4% total return on stocks in 1999. But others are not so glum, arguing that slow growth will encourage the new European Central Bank to keep interest rates down, thus supporting stocks. Mark Howdle, strategist at Salomon Smith Barney, expects European equities to deliver 12% returns in 1999, and that could go even higher if easy money pumps up the markets. Even more support could come from retail investors, a new breed in Europe, who showed remarkable resilience during the recent decline. Flows into European equity mutual funds tailed off in August, but net withdrawals were only about $500 million. Inflows kicked up to $2 billion in September. Markets may benefit as well from Europe's merger boom. They roared back to life after the summer doldrums with November's $58.5 billion in deals, according to J.P. Morgan. The euro will fuel the fire by ratcheting up competitive pressures. Expect more action in pharmaceuticals and financial services after the recent tie-ups between Britain's Zeneca and Sweden's Astra and Deutsche Bank's takeover of Bankers Trust. Banking seems sure to consolidate further with Britain's Barclays Bank and Halifax, Spain's Argentaria, and Germany's Commerzbank and Dresdner, the subject of speculation. Industries under pricing pressure will also see more deals. Elf Aquitaine and Royal Dutch/Shell may look to bulk up in oil, and British chemical stalwart ICI may shed its acrylics unit and buy more specialty chemical makers. THINK BIG. The euro will also change investment patterns enormously. Euro zone investors, who have traditionally concentrated on their national markets, are gradually diversifying into broader European portfolios. Just as it no longer matters much to U.S. investors whether a company is headquartered in California or Illinois, Europeans are starting to worry less whether they buy a Spanish or a German company. As a result, potentially huge flows could boost many Continental stocks. And blue chips could well be the big gainers. ''You begin by investing in the biggest stocks in other countries,'' says Bernard Fauche, head of equities at CDC Asset Management in Paris. Changes in benchmarking will bring other opportunities. Portfolio managers will increasingly be measured against Europewide indicators such as Morgan Stanley Capital International's MSCI Europe index or the Dow Jones Euro Stoxx 50 rather than Frankfurt's DAX or the CAC 40 in Paris. But investors trying to beat managers into must-buy stocks need to watch out for index quirks. Stoxx 50, the euro zone's top 50 blue chips by market capitalization, is heavily weighted with bank, telecommunications, insurance, technology, and energy issues. Stocks such as Allied Irish Banks PLC or Portugal Telecom may get an extra lift as the only ones from their countries in Stoxx 50. As European stocks become one big market, other important changes will happen. Industry professionals are shifting from a country to a sector approach. Economic integration will cause stocks across sectors to behave in a similar fashion, explains Martin Luley, head of equity portfolio management at Commerzbank International Capital Management in Frankfurt. ''You won't be able to add much value in overweighting or underweighting countries,'' he says. Already, some strategists and portfolio managers are trying to pick winning sectors and the best stocks in them. Food and beverages are a popular play because consumer spending is expected to outpace business investment. Dugan likes French food giant Danone Groupe, a restructuring play less exposed to emerging markets than Switzerland's Nestle. He also recommends insurers Aegon of the Netherlands and Germany's Allianz, which he believes are undervalued. In fact, John Bennett, investment director for Europe at Global Asset Management in London, gives insurance stocks the heaviest weighting of all, with picks including Germany's Munich Reinsurance Co. and Switzerland's Zurich Allied. Managements are transforming them from low-margin businesses to operations that can command premiums for service, he says. BIG SQUEEZE. A few other industries can withstand lackluster economic trends and post growth. Bennett likes drugmakers such as Novartis, Roche, Pharmacia & Upjohn, and Glaxo Wellcome. He also likes technology plays such as French computer-systems consultant Cap Gemini and Logica PLC, a systems developer in Britain. Deflationary pressures, however, will also produce dogs by squeezing margins in many industries. Bennett's GAM European hedge fund, for one, is shorting airlines and chemicals. He doesn't think much of telecommunications, either, which he pans as last year's fad. Other pros still think the potential of the Internet and mobile technology can't be ignored. Popular picks include Telecom Italia Mobile in Italy, Britain's Vodafone Group, and Finland's Nokia. But even the bulls think 1999 will be challenging. This caution comforts some pros. Anthony J. Bolton, senior investment director at Fidelity Investments in London, thinks the summer's pummeling can be traced to too many investors buying into the euro in advance of the currency's launch. Then, when they realized that growth would be less than they had hoped, they bailed out. Will this year's caution guarantee a smoother ride? Don't bet on it. By Stanley Reed in London, with Sharon Reier in Paris and Margaret E. Popper in Madrid RELATED ITEMS TABLE: European Stocks to Watch Return to top of story

Updated Dec. 17, 1998 by bwwebmaster
Copyright 1998, by The McGraw-Hill Companies Inc. All rights reserved.
Terms of Use