The coming of a single currency to Europe next year is sparking a frenzy among investors on the Continent. Amid signs that the euro will force markets to be more efficient and companies to consolidate and restructure, stock markets have soared in the past 12 months. Italy is up 60%, in dollars, and the Netherlands up 30%. But euromavens think their markets still aren't overvalued. "It's exuberance, but it's rational," says Nick Knight of Nomura Securities in London. "Europe has a lot going for it."
The biggest plus: Even traditionally profligate countries have brought their budget deficits down, so long-term interest rates have fallen. Most 10-year bond yields are hovering around 5%. "If you assume this environment will last, stocks look cheap," says Knight.
One way to ride the wave is via mutual funds that track European stock indexes. Despite their good performance over the past year, several closed-end country funds still trade at around a 15% discount to their net asset value, such as the $100 million Irish Investment Fund (800 468-6475) and the $103 million Portugal Fund (800 293-1232). An alternative is an open-end fund that spreads its assets among all the major European indexes, such as the $2.5 billion Vanguard Equity Index European Fund (800 662-7447). It boasts a 12-month total return of 47.6% and a modest expense ratio of 0.35%.
For stock pickers, perhaps the purest plays on the euro are shares in banks and insurers, which are morphing from domestic into regional businesses marketing products in one currency. "The financial sector is going through a process of restructuring that has a lot of potential," says Andrew Jacobson, who manages Pacific Investment Management's new International Growth Fund (800 426-0107). Jacobson favors "Club Med" players in Southern Europe, where fiscal discipline has improved the most. Among those are Spain's Instituto Nacional Assuranz, Italy's Credito Italiano, and Portugal's Banco Portuguese de Investimento. Besides benefiting from lower inflation and interest rates, they're dumping assets and cutting costs.
TOO HIGH? Some managers complain that the prices of such southern plays are already stratospheric. Instead, they favor cheaper financial companies that have restructured so aggressively they're likely to remain profitable even if interest rates turn up. Omid Kamshad, senior portfolio manager for Putnam's $2.5 billion International Growth Fund (800 225-1581), likes financial stocks in the Netherlands, Sweden, Ireland, and France. "Valuations [there] aren't stretched yet," he says. His holdings include the Netherlands' ING Group, Allied Irish Banks, Swedbank, and France's Societe Generale and Banque Nationale de Paris.
Another beneficiary of monetary union is the software industry. Companies are spending billions to retool computer systems for the euro, and information technology providers "are almost all winners," says Jacobson. He owns Germany's SAP, the Netherlands' Getronics, and Norway's Mercantile Data. Other service providers are cashing in on the euro less directly. In their drive for competitiveness, more big corporations are outsourcing expensive functions such as food service. James Seddon, who co-manages the $1.2 billion T. Rowe Price European Stock Fund in London, is high on French caterer Sodexho and Britain's Compass, which just won a global food-service contract from electronics giant Philips.
With all the europhoria, it's not easy to find bargains. But some remain among smaller companies, says Stephen Beinhacker, senior vice-president at Alliance Capital Management in London. Companies whose fortunes don't depend on a single currency also are worth a look. Beinhacker points to Spanish oil refiner Repsol, which is restructuring but is trading at just 13 times estimated 1998 earnings, vs. an average of 25.4 for the Spanish market. Even if you're not exuberant over Europe, the Continent is full of opportunities for rational investors.