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"Everyone Is Selling, No One Is Buying"


Europeans are recent converts to the cult of equity. But by now, many European investors must have decided that their newfound faith was misplaced. After 2 1/2 years of declines, markets are suffering a crisis of confidence that shows no sign of abating. In London, the FTSE 100 index is off 36% since its December, 1999, peak. Germany's Xetra DAX 30 has fallen by almost half, and France's CAC 40 is down by 47%. "The market sinks lower and lower," laments Matthew Patterson, a broker at Metzler Bank in Frankfurt. "Everyone is selling, no one is buying."

Now, the fear is that falling markets are touching off a broader landslide. One worry is that European insurers will be forced to step up sales of their equity holdings to meet capital requirements and cover losses--and thus accelerate the markets' plunge. In Britain, for instance, insurance companies own one in three shares, far more than in the U.S. "There's a distinct possibility that the markets could fall 40% more," says Hugh Hendry, a hedge-fund and mutual-fund manager at Odey Asset Management in London. That would mean a return to levels not seen since 1995.

Even if such predictions are too dire, the long bear market is having a far-reaching impact. Brokerage firms and investment banks have been hit hard, of course, as their business dries up and they're forced to lay off thousands. But companies of all stripes are suffering as they find it tough to raise money for expansion. In announcing on July 4 that the European Central Bank will hold interest rates steady, President Wim Duisenberg said he worries that the market's behavior could slow the economic recovery by making it difficult for companies to raise cash for investment. Perhaps most important, a generation of European investors may sour on stocks--a setback for a shareholder culture that took years to develop. "What makes this situation particularly worrying is that it is the first time since the war that a bear market has coincided with an economic upswing," says St?phane Garelli, a professor at IMD International Business School in Lausanne, Switzerland. "It could not only damage the equity culture but hurt the recovery."

If no one's buying the old stock, there's not much point in selling new stock. So a slew of European companies have scrapped long-planned initial public offerings in recent weeks. On June 26, Milan fashion house Prada canceled its flotation for the third time in a year. Irish drinks company Cantrell & Cochrane yanked its $1 billion IPO on July 8. The handful of brave companies still determined to go public are being forced to knock down their prices. Hip London retailer Burberry Ltd. was expected to debut at $4 a share on July 12, 10% less than it was predicting at the end of June. "Despite the good-quality companies looking to go public, investors are reluctant to commit themselves and are chasing prices down," says Tom Troubridge, a partner at PricewaterhouseCoopers in London.

That's bad news for investment banks: Their fees from mergers and acquisitions are at an eight-year low. M&A activity involving a European company was down 28%, to $323.44 billion, in the first half of the year, compared with a dismal first half of 2001, and down 67% from the same period in 2000, according to investment-banking analyst Dealogic. And it's not likely to pick up anytime soon. The market sell-off increases the number of attractive targets with cheap shares, but it also means that many companies are unwilling to auction themselves off at such low prices. Moreover, potential buyers can't be sure of raising money in the capital markets to finance deals. So investment banks will keep shedding jobs. The Center for Economics & Business Research Ltd. predicts that for 2001-2003, a total of 21,000 positions in the City of London will be eliminated.

Meanwhile, the slump in share prices has led disgruntled investors to turn up the heat on the leaders of Europe Inc. Deutsche Telekom CEO Ron Sommer is facing intense pressure to step down as the company's shares hover 22% below their 1996 IPO price. Shares of Credit Suisse Group have fallen 39% this year, leading to calls for the head of Lukas M?hlemann. On July 2, he agreed to step down as chairman next year but will stay on as CEO, though many analysts doubt he'll last until then. For now, the market turmoil makes it hard for him to plug some of the company's holes by selling Winterthur, its money-losing insurance arm.

Governments on the Continent have a similar problem. The steady drop in asset values is throwing a spanner into their plans to privatize state-owned companies and reduce their swelling budget deficits. This is particularly a setback for France's new Prime Minister, Jean-Pierre Raffarin, who was hoping to sell stakes in utilities such as Electricit? de France and Gaz de France. Across Europe, politicians also are likely to face growing resistance to long-awaited plans to boost private pensions. Workers will have little interest as long as markets head south.

So what will it take to get stocks to reverse direction? Probably a bigger drop in valuations. "Valuations aren't compellingly cheap yet," says Michael Hartnett, director of European equity strategy at Merrill Lynch & Co. in London. On average, European shares are trading at around 20 times earnings, vs. about 25 in the U.S. But the market won't pick up again until major blue chips such as Deutsche Telekom, Britain's Vodafone, and even BP trade at roughly 10 times earnings, argues fund manager Hendry. In all European bear markets since World War II, markets didn't bottom out until price-earnings ratios fell to the 5-to-12 range, he says.

So what does a bear like Hendry buy? His strategy is to follow the money, and he has managed to top Standard & Poor's ranking of European mutual funds in the first half. His fund is up 15%, while the average European fund is down 7%. For many years, excess liquidity has gone into the stock market, but now, he says, it's going into hard assets, such as gold and property. So Hendry is snapping up shares that play on that trend, such as Dutch shopping-mall developer Rodamco and South African gold-mining company Durban Roodepoort Deep Ltd. "It's the height of madness to be fully invested in equities now," says Hendry. No doubt many a disillusioned European investor agrees. By Kerry Capell in London and David Fairlamb in Frankfurt


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