In just a matter of weeks, Europe's business climate has been transformed. As recently as mid-July, investors thought the Continent was on the verge of a long-awaited boom. Like their U.S. counterparts, European companies seemed to shrug off Asia's economic meltdown for nearly a year. But ever since Russia's debt default on Aug. 17, the rot that began in the emerging markets has begun seeping across Europe's borders and into the results of its top corporations.
Withering demand from Asia, Latin America, and Russia is cutting into growth forecasts. The chances of a serious slowdown in the U.S., another key export market, have also risen. And ripple effects from the troubled global economy are likely to pressure Europe's corporate chieftains, perhaps forcing cutbacks in spending and hiring plans.
In the span of a few days in September, the markets were slammed by a series of nasty surprises from several blue-chip companies (table). On Sept. 17, Alcatel CEO Serge Tchuruk announced that the company's major European customers were slashing orders by up to 37%. Then, Dutch conglomerate Philips Electronics, British entertainment giant EMI Group, and Royal Dutch/Shell Group all said their upcoming results are likely to be worse than expected. "The outlook is getting bleaker," says James E. Cornish, an equity strategist at BT Alex. Brown in London.
Each burst of bad news sends another shudder through the investment community. "People are looking for the next downgrade, not knowing where it is going to come from," says Gary Dugan, European equity strategist at J.P. Morgan Securities Ltd. in London. Dugan expects corporate earnings across Europe to rise by just 5% next year--a big drop from the 18% Morgan was forecasting in July.
While some companies are seeing improving results, Europe seems full of risks. Currencies of the 11 countries expected to enter the European Monetary Union are rising against the dollar and sterling, making the region's goods less competitive. Britain, which takes roughly 16% of the EMU countries' exports, may have almost no growth next year.
Manufacturers' stock prices have been particularly hard hit. Fiat, for instance, was full of fire a few months ago after pouring $2.2 billion into auto plants in Brazil and Argentina. But with Brazil flirting with financial catastrophe, those investments no longer look so brilliant. Weakness in Latin America contributed to an 11.2% drop in operating earnings in the first half.
Analysts worry that lost sales from emerging markets will lead to a turndown at home. Bruce Kasman, J.P. Morgan's chief European economist, now expects European companies to increase capital spending by 5% next year rather than 10%. That could affect hiring and consumer spending. Morgan has cut its average 1999 growth forecast for the 11 countries planning to adopt the single currency to 2.5% from 3%. BT Alex. Brown expects less than 2% growth in Germany and France next year.
JOB LOSSES. On Sept. 18, Royal Dutch/Shell Chairman Mark Moody-Stuart warned that the global business climate in the second half of the year will be "significantly worse" than in the first half. That, he said, will prompt Shell to speed up its disappointingly slow restructuring program. Redundant local headquarters in Britain, France, Germany, and the Netherlands are to be closed, with some associated job losses. Assets may be written off.
Despite the pessimism, Europe could actually outperform the rest of the world. Merrill Lynch & Co., whose experts believe the biggest global growth contraction since the oil crisis of 1973-74 is in the works, is still relatively bullish on Europe, largely because of the coming single currency. But the robust recovery that Europe was hoping for after years of stagnation could turn out to be a grand illusion.