European stocks soar Analysts disagree if bull run will last

August 14, 1993|By Ian Johnson | Ian Johnson,New York Bureau

NEW YORK -- European market observers can agree on at least three things: European stocks are booming after three years of lackadaisical growth; the bull run is fueled by the demise of the European monetary system; and, the surge holds great opportunities for investors.

But there they part ways. Analysts disagree on whether this surge will continue as dramatically as it started and whether it really signals a turnaround in the continent's beleaguered economies.

Regardless of how one interprets the run-up of Europe's stock markets, the immediate facts are indisputably startling.

Since the system's Exchange Rate Mechanism (ERM) was relaxed at the end of July -- a move that should allow European countries steep interest rate cuts and, hopefully, economic growth -- the French market is up 8.6 percent, the Spanish market 7.6 percent, the Italian market 7.4 percent, the German market 6 percent and the British market 5.2 percent.

Yesterday, the Financial Times-SE 100 index hit a record for the third consecutive day. Germany's DAX index of 30 blue chips hit a three-year closing high. French stocks fell after Prime Minister Edouard Balladur failed to suggest aggressive cuts in rates, though the CAC 40 index hit a record Wednesday. And in Spain, the Ibex index closed at a yearly high for the third straight day.

Record-high markets have also been set recently in smaller markets, including Sweden, Switzerland and the Netherlands.

At first glance, the markets' performance seems startling given the continent's most serious economic downturn since World War II -- including high unemployment, failing businesses and lTC negative growth -- as well as the crisis surrounding the reformation of the ERM.

The ERM, which was supposed to lead the way to a common economic policy in Western Europe, controlled exchange rates between countries of the 12-member European Community. The idea was to facilitate trade by eliminating currency fluctuations.

But when the system proved too inflexible for Europe's divergent economies, it fell apart, forcing European politicians to concede that economic union would take years longer than first expected. Now, though most currencies remain linked to the system's anchor, the German mark, they are connected much more loosely.

While a severe blow to European unity, the near-collapse of the system allows many countries to lower interest rates as they are no longer bound by the constraints imposed by the ERM. Already, France and Spain have cut interest rates and allowed their currencies to fall against the mark. Other countries could follow in the coming weeks.

"This latitude for individual countries to lower interest rates has been the catalyst for the markets' surge,"said Andy Williams, a ,, strategist with Glenmede Trust Co. in Philadelphia.

The expectation, Mr. Williams said, is that lower interest rates will fuel economic growth, improve corporate earnings and channel investors' money out of money market funds and into the stock market -- a scenario similar to the one taking place in the United States.

While this scenario should hold up in the long run, it might be premature to expect any large cuts in interest rates, said Marcus Grubb, an economist in Salomon Bros. Inc.'s London office.

And slowness in cutting rates could give many markets the jitters, he said.

"The market's timing may be a bit ahead of the actual facts," he said. "The countries seem to be cutting their rates slower than expected, something the market hadn't expected."

A more fundamental concern is equating currency devaluation -- the de facto effect of the decision to allow most currencies to fall against the German mark -- with good economic planning. Alan Snyder, headof Snyder Capital Management Inc. in San Francisco, said historical trends show that devaluation is of little long-term help for an economy.

"In the long run, a strong currency is a sign that a country is doing something right economically, which is good for business. Weak currencies show that something is wrong," Mr. Snyder said.

But as Keith Gardner, who runs a global fund for Baltimore's Legg Mason Wood Walker Inc. pointed out, markets have been less interested in basic economic conditions than with interest rates.

"This has been a sea change in that markets are now fixed on interest rates. So even though the economies in Europe are projected to be weak through next year, the markets should perform well," he said.

Mike Howell, global strategist with London's Baring Securities Inc., agreed, saying investors can expect a repeat of the U.S. experience. "What we're watching is a move that's being shown three times: First in the U.S., then Japan and now Europe."

While this should portend well for U.S. investors wanting to spike their portfolio with Europe's high-performance stocks, analysts agreed that unfamiliarity with European countries and the need for diversification make mutual funds the best bet.

George Murnaghan, a vice president of Rowe Price-Fleming International, which manages T. Rowe Price's international mutual funds, said investors have been drawn to the Baltimore-based company's International Stock Fund, which is invested 50 percent in Europe, and its Europe Stock Fund.

"Europe represents relatively good value," Mr. Murnaghan said. "The stocks have been up but there's no reason why they can't continue to rise steadily in the future."

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