Surf's Up Abroad

Jim O'Neill is trying hard to keep his composure. The head of global research at Swiss Bank Corp. in London, O'Neill last year spotted signs of surprisingly strong corporate profits despite the Continent's worst recession in decades. So what did it get him? Exasperation. European stocks, hit by inflation worries and dimming hopes for new Bund-esbank interest-rate cuts anytime soon, followed the U.S. bond market south, tumbling 8% since Dec. 31. "The biggest dilemma hitting markets this year," says O'Neill, "is that we've got economic growth."

But that's hardly the case in Japan, where the Nikkei stock average has risen 19% this year amid signs of an economic turnaround and hopes that record-low short-term interest rates will fall even further. In fact, investors in Japan may be leading a worldwide trend. Despite Europe's recent jitters, evidence is growing that a low-inflation recovery is taking root across the industrial world. Better yet, the recovery could propel corporate earnings sharply higher as restructuring campaigns around the world pay off. In Europe, the phenomenon of the corporate shakeup has a way to run. And in Japan, many companies are still in the early stages of making themselves over.

Indeed, hopes for a big jump in Japanese profits--along with Washington's decision to stop talking the dollar down--has carried the Nikkei stock

average to around 21,000 this spring. And Goldman Sachs (Japan) Co. strategist Kathy Matsui sees a discount rate cut between July and September sparking the market to 23,500 by next year.

Maintaining that the Japanese "are restructuring their way out" of recession, she is also banking on heavy-duty cost-cutting generating big profits from even modest sales increases. A big drop in depreciation expenses left over from the capital-spending boom of the 1980s will help, too. For these reasons, Rod Smyth, strategist for Baring Securities (Japan) Ltd., figures major manufacturers' profits will be up 40% this year, although sales may rise only 1.1%. Smyth is recommending Komatsu Seiren, a maker of printed fabrics, plus exporters Sony, Sanyo Electric, and Hitachi, in anticipation of rising consumer demand at home and abroad. But Matsui favors cyclical issues, including steelmakers NKK, Yodogawa Steel Works, and Aichi Steel Works. Cyclicals also beckon to Craig Nelson, head of management at Jardine Fleming Securities Ltd., who has been moving cash into polyester maker Teijin Ltd.

In a time of wrenching political and economic change in Japan, it's not surprising that a passel of less traditional stocks are making their way into the pros' portfolios. Thomas Norton, a New York-based specialist in Japanese over-the-counter issues, is focusing on companies that have figured out ways to skirt Japan's high-priced distribution system to tap what he calls the "silent revolution" of Japanese consumerism.

IN THE BAG? Contact lens maker Seed, for example, has spawned a thriving wholesale business in eyeglasses that sell for 65% off retail. He also likes Shohkoh Fund, a finance company that "flies under the radar of the banks" to reach small-business borrowers. The company's earnings have quadrupled since 1989, and Norton sees them rising 13% in '94.

If Japan's recovery looks increasingly like it's in the bag, Europe is still trying to figure out when good news on the corporate front will translate into a clear upward market move. What could help spark such a move is some action by the German central bank. Usually rock-steady in its pursuit of sound money, the Bundesbank has issued a babble of conflicting statements lately as a surge in money growth has given rise to new inflationary expectations. Amid the confusion, investors have come to believe they have seen the Buba's last interest-rate cut for a while.

But the Buba could yet give markets a pleasant surprise. Andrew Williams, vice-president at Philadelphia's Glenmede Trust Co., figures that a weaker U.S. dollar later this year will provide the Bundesbank added leeway to resume lowering rates. That will help economic growth and profits, to be sure. Less obvious, however, is the impact that enormous cost-cutting is having on corporate bottom lines. "The earnings of companies with cyclical leverage are still being underappreciated," figures Merrill Lynch & Co. European strategist Michael Young, who recommends Finnish diesel-engine maker Metra Corp. and metals producer Outokumpu. Morgan Stanley & Co. analyst Chris Moore likes Italian auto maker Fiat, which could be back to breakeven this year after a $1 billion loss in 1993. By 1995, estimates Moore, Fiat could be earning $1.06 per American depositary receipt. And Swiss Bank's O'Neill recommends German chemical maker Hoechst, France's telecommunications giant Alcatel Alsthom, and Swiss construction giant Holderbank Financire Glaris.

Even as they invest for a low-inflation growth cycle, some pros are hedging their bets a bit. They are going into natural-resource stocks, just in case the firming world economy starts to nudge prices up. One favorite of many analysts is Britain's RTZ Corp., a pure play on copper prices. BT Securities analyst Warren Toft in Sydney is buying Broken Hill Proprietary Co., a big Australian producer of copper, steel, and energy. And Glenmede's Williams gravitates to France's Elf Aquitaine. Cost-cutting and a spin-off of state-owned shares should boost Elf's efficiency and investor payback, he says. With its shares trading at 4.5 times cash flow, vs. 6 for competitors, "it's the cheapest major oil company in the world."

That's the allure of global equities right now. Despite a growing appreciation of the two Rs--recovery and restructuring--many stocks overseas are still within reach. On many bourses, pleasant surprises could become routine as the global rebound gathers speed.

      Company         Price per share (dollars)
      MANNESMANN  GERMANY            $267
      Its mobile-phone unit is a big plus
      Making a bundle selling
      pre-fab homes                   $10
      Company         Price per share (dollars)
      SEED  JAPAN                     $10
      Discounts contact lenses and eyeglasses
      Brewing & dairy group mixes
      booze and moos                  $21
      Company         Price per share (dollars)
      World's cheapest big oil stock  $36*
      Low-cost reserves if you think
      gold will boom
      DATA: BUSINESS WEEK SURVEY OF FUND MANAGERS AND ANALYSTS        *American depositary receipt
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