Rebound? You Wouldn't Know It From The BoursesBill Javetski
European inflation is tame, and upward revisions of profits and growth forecasts are coming weekly. So you might think that Nicholas Knight, Nomura Research Institute Ltd.'s London-based strategist, would be counseling clients to pile into equities. Guess again. "If the macroeconomic side is so good, I ought to have a long list of stocks I'd like to buy," he exclaims. "But I'm struggling."
Call it Europe's unconvincing recovery. Booming exports of paper, chemicals, and electrical equipment to the U.S. and Asia have stunned skeptics and are producing a faster-than-expected turnaround from the Continent's worst recession in decades. Capacity utilization is on the rise, and industrial output is soaring in Germany, Italy, and other Euroeconomies. The European Union now expects gross domestic product of its 12 member states to expand by 2.1% this year--up 0.8 percentage points from its forecast just a few months ago--and 3.2% in 1995. In Germany, Europe's largest economy, many analysts figure the pace could be even hotter.
But stock traders are acting as if the boom could be short-lived. Europe's equity markets have slumped an average 6% this year (chart). Stocks are down by more than twice that in France and Denmark. Only three bourses--Stockholm, Helsinki, and Milan--are ahead for the year. What's more, few analysts see markets breaking out of the blues anytime soon.
TOO MUCH BAGGAGE. Rising global interest rates certainly have a lot to do with Europeans' gloom. Since the U.S. started raising rates last winter in the face of strong economic growth, the cost of borrowing has been on the rise across Europe. Amid global inflation fears, long-term rates have risen by nearly 2 percentage points in Germany and 4.5 points in Sweden. The increases have put pressure on short-term rates as well. Nervous bond markets could force the Bank of England to raise short rates a second time by early 1995. To many economists, it's only a matter of time before Germany's Bundesbank and its allies in the Netherlands, Switzerland, and France join the pack.
Adding to the chill is a new set of doubts that even after extensive restructuring, Europe still carries far too much baggage to thrive in a global economy. The region's continued struggle with 11% unemployment, high wages, and inflexible working conditions is likely to keep earnings below the levels necessary to attract sufficient capital to prolong investment and growth. "There is a lot of skepticism over whether companies will be able to earn adequate returns," says Deutsche Bank Research analyst Peter Metzger.
On top of that, consumer demand through much of Europe is still lackluster. In Germany, where retail sales are already weak and taxes to pay for unification are about to rise, "there's no evidence there will be any significant pickup in private consumption over the next 12 months," says Union Bank of Switzerland Frankfurt economist Richard Reid. And in Italy, despite an export surge fueled by the devalued lira, regions and sectors that are linked to government spending and domestic demand are in trouble.
Indeed, warning signs of a possibly aborted recovery are already appearing. Take Britain's Imperial Chemical Industries PLC. In October, ICI announced that its third-quarter pretax profits jumped 82%, to $210 million, on a mere 8% gain in revenues. But in the past six months, ICI's stock price has sagged 4%. One reason: Lehman Brothers Inc. analyst Martin Glen sees "a fairly substantial risk of a slowdown in demand in the middle of next year" as buyers finish inventory restocking, and weak consumer demand keeps prices soft. At France's Rhone-Poulenc, CFO Jean Pierre Tirouflet complains that despite rising sales volumes, the chemicals maker hasn't been able to win a price increase since 1992.
SQUEEZED MARGINS. The prospect of major job losses amid corporate shakeups is certainly weighing on consumers. Texas Instruments Inc., for example, decided to undertake a massive regional restructuring when Europe turned up this year. To save about $54 million annually, it slashed 2,000 out of 6,300 jobs. But Marco Landi, head of TI's European operations, notes that "the same kind of restructuring we have done is what must be done" across Europe. Indeed, Germany's Siemens, among others, is now undergoing a sweeping restructuring to slash costs. "What the U.S. has gone through for the past 15 years, Europe is going to go through for the next 10 years," says Merrill Lynch & Co. European strategist Michael Young.
Such restructuring should be good news to investors. But so far, they remain unconvinced. Young maintains that global competition will squeeze profit margins and drive down price-earnings ratios by 50% over the next three to five years. Investors are so skeptical, in fact, that when Germany's Krones, a world leader in bottle-labeling equipment, announced that earnings would not be up to analysts' expectations, its shares plunged 30% in one day.
On top of the profit worries, analysts fear that Europe's export recovery could fizzle out rather quickly if growth in the rest of the world slows. The prospect of a global slowdown might very well take the pressure off bond markets. But for Europe's battered bourses, slower growth would only spell gloomier times to come.