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Pockets of Europe showing signs of competitiveness

NY TIMES NESW SERVICE, LONDON
Sunday, Jun 08, 2003, Page 12

US President George W. Bush discovered again last week what many American investors have known for years: Some countries in Europe offer a far better reception than others. Some stock markets, mainly in the faster-growing southern and eastern fringes of the continent, have generated much greater returns recently than the core markets of Germany, France and the Benelux countries.

Most European markets are ahead this year when returns are expressed in dollars, mostly because of the 12 percent gain in the value of the euro. Without the benefit of the exchange rate, several markets would have double-digit percentage declines.

The best performers have been in the east: The Czech market recorded returns in dollars of more than 34 percent this year through Thursday, according to Morgan Stanley Capital International. Spain has been the region's best developed market, rising 22 percent in dollars; the worst, the Netherlands, is up 2.8 percent.

"Economies are doing a bit better, and stock markets have performed a lot better over the last two to three years" in Spain and Italy than in France and Germany, said Guillaume Rambourg, a manager of European equity portfolios at Gartmore Investment Management, a division of Nationwide Mutual Insurance of Columbus, Ohio.

The developing economies in Central Europe are attractive, some managers say. "The Czech Republic, Hungary and Poland are all growing 2 to 4 percent," said Chris Alderson, who manages the T. Rowe Price Eastern Europe and Mediterranean fund, which has gained 19.9 percent this year through Thursday. "I would expect that differential to continue."

The three central European countries, and seven from the region's outskirts, are set to enter the EU next year. That has already helped propel stocks higher in many of them, but Alderson said he thought that "equities still offer a lot of value." He likes companies that focus on their domestic markets.

Most mutual funds that concentrate on Europe stick to the major western markets or, as the T. Rowe Price fund does, the region's emerging markets. Most funds that concentrate on Europe invest throughout the region's developed countries or, as the T. Rowe Price fund does, the emerging markets. Investors can focus on specific countries through closed-end funds listed in the US.

Favoring the periphery

Portfolio managers generally agree that discrepancies in economic output and investment returns will remain across Europe. These managers continue to favor the periphery over the core, although most do not put it quite that way. Since the introduction four years ago of the Economic and Monetary Union, the program linking currencies and monetary policies across 12 countries, it has been customary for fund managers and analysts to view Europe as a single entity when picking stocks.

Nevertheless, many of the stocks they pick happen to be in the outlying countries, a reflection of the economic momentum of these nations as they modernize and diversify their industrial bases and deregulate labor markets, giving them distinct competitive advantages over their neighbors.

"No question, we are finding more opportunities in places like Spain at the moment than Germany," said Bob Yerbury, chief investment officer of Invesco UK, a division of Amvescap, a British-American company that owns the AIM and Invesco funds.

Constraints of the monetary union are also taking a toll on the core European countries. Interest rates are set for the region as a whole, and, in the view of critics, are set too high for the mature economies. Restrictions on fiscal policy limit the ability of governments to stimulate growth by borrowing and spending.

The system has had a harsher impact on Germany than its neighbors, especially as the prospect of deflation arises. The German mark is widely acknowledged to have been pegged at too high an exchange rate at the inception of the euro, implying that growth may have to be lower for years in Germany than in the rest of the EU to undo the imbalance.

With an industrial base in recession and a deeply distressed banking sector, Germany is often likened to Japan, which has been economically moribund over the last decade. Alan Brown, chief investment officer at State Street Global Advisors, said: "There is a real risk that Germany will slip into both recession and deflation. While I am not suggesting that we face in Germany the likelihood of a depression of the magnitude experienced in the 1930s, I am saying that the policy mix today looks remarkably similar to that of the late 1920s."

Brown said that France "could also fall into this trap," although he said there were mitigating factors. The French economy is more diversified, he said, and the franc was pegged to the euro at a more favorable rate. "Plus, there has been somewhat more life in consumption so domestic demand has been a little better," he said.

Lower expectations

Because expectations are so low among investors, some contrarians expect mature European markets to rebound in a global recovery. "The core, cyclical markets in Europe, like Germany, the Netherlands and France," should surge, said Barton Biggs, a strategist at Morgan Stanley, in a note to clients. "There are too many stale bears on Europe, and prices have fallen too far."

The core European markets are the ones to own for anyone betting on an economic upturn, Rambourg said, but it is not a bet he is willing to make. "We're stock pickers, and we're struggling to find good companies with earnings coming through," he said. "Holland was our biggest overweight in the good old days; now we're neutral to underweight. We're overweight in France, Spain and Italy."

He prefers some French companies partly because they do much of their business somewhere else. Among his favorites is the oil company TotalFinaElf, which he likes for the quality of its management and its high profit for each euro of capital it invests. He also favors the cosmetics maker L'Oreal and the pharmaceutical companies Sanofi-Synthelabo and Aventis. All four trade on the New York Stock Exchange.

"That doesn't mean I have a bullish view on the French market per se," Rambourg said. "France Telecom and Vivendi were big disasters." Each, in dollar terms, is down by about 75 percent from its peak.

A smaller problem, he said, has been Sodexho Alliance, a French food-service company that has a large contract with the US Army. Sodexho's stock has fallen, reflecting fears that the Army will cancel or reduce the value of the contract in a postwar, anti-French backlash. A cancellation would be a "massive loss to the company," Rambourg said.

Any fallout from the American rift with France, a vocal opponent of the war in Iraq, should be limited to specific stocks like Sodexho, he said.

Yerbury at Invesco agreed.

"My view is that these things pass," he said. "There are stories at the moment of people pouring claret in the gutter; that's a terrible waste of good wine. We saw that sort of thing happening before with various trade arguments. Quite often we find the French and the United States involved, usually on opposite sides. I hope reason prevails and everyone starts to realize that free trade is good for the global economy."
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