Comment / Columnists
BARRY RILEY: Aim for bourse without borders
Europe is upstaging Wall Street, and the euro offers investors hope for even more vigour, says Barry Riley
Shares on Wall Street may have been gliding ever upwards, but recently European ones have been doing even better. So far this year, the index for Europe excluding the UK is up 28 per cent in dollar terms - nearly twice Wall Street's gain. This sparkling performance has focused renewed attention on the potential of the historically unexciting Continental European bourses.
Hopes are high that the euro will provide the trigger for a revitalisation of the Continent's fragmented capital markets. At the very least, the single currency will lead to a profound shake-up in the operations of stock exchanges and financial institutions.
"A broker's life will change more over the next two years than at any time in the past," says Mark Brown, strategist at ABN Amro. And Jan Mantel, chief investment officer for Europe at Dresdner RCM Global Investors, says funds across Europe will be forced to re-balance and reorientate their portfolios. "It will be the mother of all programme trades," he promises.
Potentially, there is more. At best, the European corporate sector could be modernised and liberated from the shackles of nationalism and political interference. The biggest prizes could go to Europe's corporate giants, which have already seen their share prices multiply under the impact of global investment flows - much of it from the US. This sector of leviathans is also being expanded through the wave of Continental European privatisations. Consider the example of Germany's Daimler-Benz. Until only a few years ago, it was a near-basket case of muddled flag-carrying and industrial conglomeration. But now it has been re-invented as a shareholder- friendly multinational sufficiently self-confident to launch, as the dominant partner, a merger with America's Chrysler.
But what about the medium-sized and smaller company sectors? Germany's Mittelstand of privately-held companies, for instance, has traditionally been a vital part of the country's economic strength. More German companies are going public than in the past, but across Europe the smaller companies are of comparatively little interest to international investors.
Thus a two-tier European corporate economy seems to be developing. Some 200 to 300 big corporations are likely to make up the pan-European market. For the foreseeable future the smaller company sectors are likely to remain primarily local and domestic - although exchanges such as the Brussels-based Easdaq are attempting to develop a Europe-wide new company market in the more glamorous and international sectors, notably technology.
The separation between international and domestic was on display in the UK last year when the FTSE 100 Index, packed with multinational blue chips, returned a growth rate of 29 per cent while the corresponding 250 Index of middle-ranking stocks rose only 10 per cent. The shift wrong-footed many of the big UK investment institutions.
As the big companies grow more international, stock exchanges are becoming aware that the need to carve out a role in the cross-border markets of the future is more pressing than their traditional focus on their domestic empires. For example, co-operation between the Paris and Frankfurt bourses, and their derivatives equivalents, is putting pressure on London, which has dominated international business.
Flagship national equity market indices composed of market leaders, such as the DAX, the CAC 40 and the FTSE 100, face a limited future: some say 10 years, others five. The race is on to design and promote the Europe-wide index to replace them: contenders so far include FTSE's Eurotop series and Dow Jones's Stoxx indices, while Standard & Poor's has a product almost ready for launch.
Which index will flash up on 21st century TV screens across Europe, as a snapshot of the day's stock market progress? We should get an early indication of the winner from the performance of the various new futures and options contracts to which these pan-European indices are being linked.
Meanwhile, the euro poses a direct challenge to Europe's labyrinth of nationalistic controls on investment institutions. Insurance companies and pension funds in many countries have been constrained to invest in domestic assets, rather than foreign ones, and restricted in their ability to hold equities rather than bonds.
But from January 1 next year a much wider choice of assets will become "domestic" for institutions in the 11 countries that will form Euroland. This will immediately open up the bond markets. And it is expected that cross-border demand for equities will increase too, as institutions become more international and governments respond to the demographic pressure for the increased funding of future pensions.
There are worries in Europe that the big winners will be the
Americans, who are used to seeing Europe in the round, rather than the Europeans themselves who will continue to be limited by their lack of perspective. Arguments are going on, for instance, about whether Europe should be carved up for investment purposes into euro and non-euro segments, and European Union and non-EU territories.
Does Euroland represent a coherent economic entity? Not necessarily from the global investor's point of view. "Dutch pension funds don't want to exclude Switzerland, with its big pharmaceutical companies," says Mr Mantel of Dresdner RCM. So investors are inventing their own economic geography: they talk about "Pan Europe" (the whole EU, including non-European economic and monetary union members, plus Switzerland and Norway) or even "Extended Pan Europe" (which includes some countries to the east).
Borders are becoming fuzzy. Stock market analysts are currently fascinated by the decline of country and the rise of industrial sector as influences on share prices. A pointed example of this shift came last month when the London-based fund management group Foreign & Colonial decided to wind up its German Investment Trust and merge it into a sister Pan Europe fund.
A Brussels firm, European Benchmarks, says four European stock market sectors can be identified: pharmaceuticals, financials, oils and consumer brands. Others are emerging as national influences fade. But investment banks conducting similar studies have come up with conflicting results: ABN Amro thinks chemicals is the most coherent sector, but Goldman Sachs cannot make the correlations work at all well.
The big investment banks are themselves well ahead with restructuring, even if their strategies vary. ABN Amro executives have just embarked on a global roadshow, emphasising the Dutch-owned institution's resources in 19 European countries. The big US investment banks tend to be more concentrated in London, from where their analysts cover the developing European megastock sector.
Investors, though, are lagging behind. Only a handful of London's big fund management houses have attempted to integrate their UK and European teams. Jeremy Tigue, manager of the giant Foreign & Colonial Investment Trust, a global fund, puts forward the typical wait-and-see argument. "It would be premature to merge the UK and Europe until it is evident whether the UK is going into Emu," he says.
According to Adrian Paine, senior portfolio manager for Europe at American Express Asset Management, US-owned managers have therefore been able to steal a lead in the Pan Europe stakes while rivals squabble about domestic versus the rest of Europe. "It's a fantastic opportunity for us," he says, claiming recent strong performance. "We just focus on the larger stocks where the change is going on." Amex's 320-stock European universe cuts off at a minimum market capitalisation of $2.5bn (œ1.5bn).
For European corporates, the surge in share prices promises a reduction in the cost of capital, and the opening up of a euro-denominated bond market will bring important benefits too. But there will also be costs of adaptation to this effective Americanisation of the capital markets.
Much depends on the acceptance by European politicians and company executives of concepts of "shareholder value". US investors have substantial aggregate stakes in the leading Continental markets, and UK institutions have some $250bn invested across the Channel. They are inclined to flex their muscles and insist that companies are run to benefit shareholders - which is still a controversial subject in several European countries where banks and trade unions have been much more important stakeholders.
Attitudes to equity buybacks, for instance, still vary, although obstructive German legislation is shortly to be changed. The acceptance of mergers remains patchy: they have become important in Switzerland, but Europe-wide cross-border rationalisation in sectors such as banking or motors, though badly needed, remains noticeable for its near-absence. And defence industry restructuring, plagued by flag carrier considerations, has proceeded at a snail's pace in Europe compared with the US.
But there is scope for progress. American investors, having given up on east Asia, are pinning their hopes on Europe to accept the baton from a tired Wall Street. "Changes in government, corporate and investor behaviour are likely to combine to raise the average valuations in equity markets in Euroland," says Mike Young of Goldman Sachs.
For the time being, though, Europe remains characteristically divided. Half of its stock market capitalisation is outside Euroland. Currency exposure will remain a problem in the UK, Switzerland and elsewhere. French socialism is a significant and obstructive force.
Battles remain to be fought. But when they are engaged, companies and investors are likely to emerge as clear winners - with a little help from the euro.
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