Dow Jones University
July 10, 1999

Measuring the Force of the Euro

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    ROME -- Six months into the euro era, some of the assumptions about how European stock markets would behave once the single currency arrived are looking shaky.

    One theory, for instance, had it that the euro would shift market volatility to industry sectors and away from individual national markets. Indexes would be moved more by, say, European auto sales figures than by a political crisis in Italy or France. Some people even predicted the end of single-country mutual funds, as Europe transformed itself into a market like the United States, where investors watch chemicals, automobiles or electronics, and not necessarily the Northeast or the Midwest.

    Indeed, European stock markets appeared headed in that direction, with announcements of planned mergers involving exchanges in Frankfurt, London, Paris, Milan and elsewhere.

    But in the euro's first half-year, it has not worked out quite that way, at least yet. Borders still count along with sectors in investment decisions, and national stock markets have been casting up widely differing returns. While France, Germany and Finland made big gains in the last six months, Belgium and Portugal have slumped, and Spain and Italy have been somewhat listless.

    Part of the explanation is that the euro's arrival has sent huge amounts of capital across national borders as currency hurdles have fallen.

    Whereas a German asset manager like Commerzbank previously had more than half its funds in German stocks, that fraction has now dropped to one-third, said Nils Stoerling, chief investment officer at the bank's asset management arm in Frankfurt. The pattern has repeated itself across the Continent, pushing up some markets and hurting others as institutions redeploy their money.

    In Spain, about 70 percent of fresh capital is going into Europe-wide investments, and only 30 percent into Spanish shares, said Eduardo Suarez, head of asset management at Santander Gestion de Activos in Madrid. A result: The Madrid stock index fell from a high in January before gaining ground again this month. "The appetite for euro equities is outstanding," he said.

    The shift is not only geographical. Money is also flowing from the stocks of small companies -- those with a market value of $300 million to $1.5 billion -- into large-capitalization European corporations that are the elite of European business. "It is something we saw from about a year ago," said Felix Lanters, head of European equity investment at ABN Amro Asset Management in Amsterdam. "And it is one reason why the big caps are outperforming the market. There is interest in top names."

    Commerzbank, Stoerling said, used to follow the old DAX 100-stock index of German companies. Now, its asset managers have assembled a 270-stock index, he said, with almost two-thirds of the companies spread across Euroland, as the euro nations are called, plus Switzerland and Britain, which have not adopted the currency.

    As had been expected, many European asset managers are also reorganizing their research, shifting it from individual European countries to industry sectors or a blend of the two. "We started looking at sectors six years ago," said David Duncan, of Global Asset Management in London.

    But, he said, his firm still casts "generally, a final glance" at geography, "to make sure you're not 95 percent in Finland, because you've liked the looks of Nokia," the hugely popular Finnish phone company.

    Eric Taze-Bernard, chief investment officer in Luxembourg at Paribas Asset Management, said many institutional investors now combine sector and regional analysis. Their reluctance to jettison regional factors, e said, was a result of their rejection of a "false idea about economic convergence."

    Rather than forcing European economies to march more closely in step, he said, the euro's imposition of uniform interest rates on differing national economies has served to sharpen cyclical differences. Lower European interest rates may help spur growth in slow economies, like Germany's or Italy's, but can overheat economies that are purring nicely, like Ireland's.

    For the moment, many asset managers expect the drive into European large-cap companies to continue. Suarez of Santander estimated that "only about 30 percent of the reorganization is done," and said it would take one to two more years before capital flows began shifting away from large-cap companies in major economies like Germany and France and toward small-cap companies in markets like Ireland, Belgium and Portugal.

    The shifting capital flows, however, are enhanced by a flood of new money that is likely to lift European stocks over all, experts say. J. Paul Horne, an economist at Salomon Smith Barney in London, said European transfers from traditional forms of savings, like bank accounts and life insurance, to stocks and corporate bonds would probably total about $1 trillion in two to three years, buoying European markets.

    And the current strength of the dollar against the euro adds to the possible allure of European stocks for American investors. Since it was introduced, the euro has fallen from nearly $1.18 to just below $1.02 on Friday. A rebound in the euro's value would add to European stock market returns in dollars. "The euro, having hit a trough," he said, "adds to the attractiveness of European securities."

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