Like Paris In The Summer, Stocks Are Sizzling

Don't try to tell stock traders that the implosion of Europe's exchange rate system was an embarrassing setback for the region's dreams of political and economic unity. On bourses across the Continent, it's being greeted as the best news in years.

Freed from the Bundesbank's tight restraints, traders argue, the rest of Europe now will be able to devalue currencies to boost exports and slash interest rates to foster growth. "This will mean a significant easing," says Michael Howell, global strategist at London's Baring Securities Ltd. And that could signal higher profits and stock prices almost across the board.

GO FOR GROWTH. Traders were betting on lower rates long before finance ministers and central bankers all but suspended the rules of the European Monetary System's exchange rate mechanism (ERM) on Aug. 1. Bourses had been rising for weeks (chart) as speculation increased that France would break loose. Indeed, just one day after the finance ministers allowed the franc and most other European Community currencies to fluctuate as much as 15% against the mark, Spain reduced interest rates a half-percentage point, to 10.5%. "The impetus is no longer coming from the Bundesbank, but from France, Spain, and other ERM members," says Howell. "They will be cutting rates aggressively." If that happens, the Bundesbank is likely to follow. Many pros figure German rates will fall as much as 2 percentage points by mid-1994, to 4.5%.

Last year, Britain, Italy, and Sweden saw stocks advance sharply after they severed their ties to the German mark amid a previous ERM upheaval. Now, many pros are recommending Dutch, French, German, and Spanish banking and insurance issues as the first to gain from lower interest rates. Wolfhard Graetz, chief investment officer at Bank Vontobel in Zurich, likes Union Bank of Switzerland, Frankfurt's Commerzbank and Deutsche Bank, and France's Compagnie Financi ere de Suez. But Joe Rooney, Lehman Brothers' London-based stock picker, favors Holland's ABN-AMRO, Switzerland's CS Holding, and Spain's Banco Santander.

Graetz also is betting that the end result of lower rates--swifter economic growth--will fire up industrial issues as well. He favors the German engineering group Mannesmann and French cement maker Lafarge Coppee. But others recommend STET, the Italian telecommunications group, which is selling at only 1.5 times cash flow. Rooney, meanwhile, recommends German auto makers Volkswagen and BMW, as well as Valeo, the French auto parts manufacturer.

In fact, many analysts continue to back French equities as Europe's hottest buys. Prime Minister Edouard Balladur needs lower interest rates if his massive privatization program is to succeed. Among the jewels up for sale will be part of the government's majority stake in the national oil company Elf Aquitaine, which many analysts already consider to be one of Europe's top picks. But Elf is hardly France's only bargain. Baring Securities strategist Howell, for one, recommends the France Growth Fund, even though it's trading at a record-high 12 3/8 on the New York Stock Exchange. And David Donnelly, portfolio manager of the Skyline Europe Fund, Has been building his holdings of chemical maker Rh one-Poulenc and Bouygues, the multinational construction group. The devalued franc will help bolster Bouygues' foreign sales, and the company also stands to gain from an improving French economy. "It's a classical cyclical recovery play," he says.

SOARING YEN. Efforts to get Europe's economy moving also have helped bolster stocks in the U.S., whose exporters depend heavily on European sales. Even Tokyo may be caught up in Europe's warming winds. Investors fleeing devalued European currencies have sent the Japanese yen soaring along with the mark. If that prompts the Bank of Japan to reduce its discount rate, traders might try to push the Nikkei stock average past 20,000, where it has been stuck for months.

Cheaper money is always a powerful tonic for stocks. But this time around, Europe's monetary cure may be even more effective than anyone suspected. Not only will it help get Europe out of recession--it also may fuel a stock market rally around the globe.