Europe: After The Bubble Bursts

Some European sectors could do well in a downturn

Investors in Europe face a very modern muddle in 2001: how to make money in the first New Economy slowdown. Old Economy problems--higher oil prices and interest rates, plus the sickly euro--cut short the long-awaited tech-driven growth spurt, which peaked at 3.5% in the second quarter of 2000. Europeans had barely gotten used to the idea of investing in dot-coms when the bubble burst worldwide. Frankfurt's Neuer Markt, which specializes in young companies, has lost more than half its value since February. The euro zone markets fell about 7% in 2000, and analysts expect they'll end 2001 higher by 10% to 15%.

"European high tech now has all the appeal of a French beefsteak," quips Simon Ferguson, a Paris-based strategist for the Swiss private bank Julius Bar, referring to the "mad cow" panic.

When an economy slows, investors traditionally sell high-growth and cyclical stocks for dividend-paying value stocks and sectors whose earnings hold up in a slump. But normally intrepid analysts say they're having more trouble than usual proffering advice. "We've never experienced a New Economy downturn, so we don't know precisely what it means," explains Johannes Reich, head of equity research at Bank Metzler, a leading German private bank. To complicate things, fund managers who track Morgan Stanley Dean Witter's MSCI index may sell euro-zone stocks and buy British issues following changes in the index's weightings.

No question, caution is the watchword of the day. Still, strategists are relatively optimistic about the European outlook for 2001. For one thing, the euro-zone economy will expand by about 3%. That figure is half a percentage point less than previously forecast, but it should match U.S. growth. If the euro continues to recover from its doldrums, European investors will repatriate some of the $250 billion they are estimated to have put in U.S. equities in the past three years. A U.S. rate cut, which would likely weaken the dollar, might help. "It could give Continental stock markets a big boost," say Achim Stranz, the chief investment officer in Germany for AXA Investment, the big French insurer. "Either way, we sincerely believe that Europe is undervalued compared to the U.S."

CROSSCURRENTS. Which sectors will do best in an environment with so many crosscurrents? Financial-services companies should do well. With the long-term solvency of state pension plans in doubt, Europeans are putting more money than ever into mutual funds and private pension accounts. That will boost the earnings of insurance companies and fund managers. Such companies are usually big bondholders and should also benefit when European interest rates start to fall. Analysts expect that to happen in the second quarter of 2001.

UBS (UBS), Switzerland's largest bank, is a favorite, says Aurelia Marxer, a strategist at Vaduz-based Verwaltungs- und Privat-Bank. After two mediocre years, she says, UBS' $1.25 trillion asset-management operation is picking up steam. UBS also strengthened its global reach by buying U.S. investment bank PaineWebber Inc. UBS shares rose 25% in 2000.

Anne Meniel, deputy head of equity management at Finama Asset Management in Paris, likes well-managed Barclays Bank, Lloyds-TBS, Italy's San Paolo-IMI, and Banca Popolare di Milano. All outperformed the sector. (Bank shares rose 30% in 2000 on heavy merger activity.)

Dropping long-term rates should help shares of insurers, says Francois Lemoine, head of equity strategy at BNP-Paribas. Lemoine likes Germany's Allianz, which should benefit from German pension rules taking effect in 2002, and France's AXA, which gains from rising retirement savings and more focus on life insurance and asset management.

WIND POWER. Anglo-Dutch consumer giant Unilever (UL), whose shares are well below their July peak of $73, is a buy. The company's U.S. acquisitions in the noncyclical food sector should boost 2001 profits. Investors like Unilever's new focus on growing markets.

Analysts are high on several European pharmaceutical companies. Switzerland's Novartis (NVS) will keep reaping rewards from its recent restructuring. Its share price has risen 10%, to $1,700, since its September announcement that it would merge its agribusiness unit with that of Britain's AstraZeneca (AZN). A softer dollar should cut imported raw-material costs and help earnings.

Along with other strategists, Metzler's Reich predicts that utilities will do well in 2001--particularly Germany's RWE Energie and E.on. Competition has transformed the once-sleepy German energy market, deregulated two years ago. Reich argues that the companies are more efficient. "German utilities will do better than their counterparts elsewhere in Europe," he says.

Despite Europe's slowing economy, most strategists like auto stocks, especially Germany's Volkswagen. It has reaped the rewards of aggressive management and marketing. Since July, its share price has risen 50%, helped by a buyback plan started in September and investors shifting funds away from DaimlerChrysler (DCX).

A New Economy pick is Copenhagen-listed wind-turbine maker Vestas Windsystems. It has a quarter of a $3 billion to $4 billion market that's growing 25% a year. Its shares rose 200% in 2000. Wind energy "is clean, and the technology is advancing rapidly," says Kraland.

It won't be an index buyer's market. But Europe's many high-quality companies could be a haven in a difficult global environment.