Currency moves to unleash bull run in Europe
TIGHT fiscal policies imposed ahead of the January 1999 target for currency convergence in Europe will put a damper on the French and German economies but unleash bullish conditions in their stock markets, a London-based fund manager says.
Rory Powe, Invesco Asset Management's continental Europe investment director, said in Hong Kong last week that the two countries' currencies and interest rates were too high.
Economic convergence, required with the creation of a single European currency, would force a 'complete reversal of the policy mix'.
Governments of countries hoping to participate in the European Monetary Union (EMU), a group that has France and Germany at its core, would have to continue to restrain spending and keep taxes high.
They would probably compensate for this by loosening monetary policy and dropping interest rates.
Low rates would weaken the core currencies as capital flowed into the high-yielding currencies of countries - such as Britain, Denmark, Italy and Spain - unlikely to join the EMU at the start.
However, low rates would improve the liquidity of French and German equities by encouraging capital to move from their money markets into stocks.
'We are seeing a reversal of currency trends,' Mr Powe said. 'The currencies that formerly were strong are going to become soft, including the deutschemark, which is very good news for the German stock market.' Hong Kong and other dollar-based investors need not be overly concerned about the potential currency risk they would face in riding the expected bull run.
'We believe they'll make more on the stocks than they'll lose on the currency, but we think there is further upside for the dollar against the mark,' he said.
Despite the likelihood of low interest rates and strong stocks, inflation was unlikely to become a problem in France or Germany because they both suffered from excess capacity and high unemployment.
Germany's capacity-utilisation rate was 82 per cent and its unemployment rate 10.5 per cent, with 4.1 million people out of work, Mr Powe said. The French jobless rate was 12.8 per cent, which translated to 3.1 million unemployed.
'So the economies have got to go gangbusters before you get inflation picking up,' he said.
Tight fiscal policy meant neither the French nor German economies would overheat, although currency weakness would eventually have a mildly salutory effect on their export sectors.
Mr Powe said the German stock market could thrive in spite of the country's overall economic weakness because the market had a more global orientation than the economy.
About 60 per cent of Germany's gross domestic product was domestically orientated, he said.
The stock market was more export-driven, but its value was worth only 27 per cent of GDP.
'It's an underdeveloped stock market. It's not a proper reflection of its economy, which reflects its lack of maturity,' he said.
'So the weaker currency won't necessarily do the economy much good, although it will do the market a lot of good.' Low inflation would foster polarisation in the stock market, with shares of efficient companies re-rated upwards.
'Companies that can grow 15 per cent when inflation is 1 per cent deserve to be on a higher multiple than ones that grow 15 per cent when inflation is 7 per cent,' Mr Powe said.
He noted there was no phrase for 'shareholder value' in the German language, reflecting the low priority traditionally given to shareholders' concerns.
This myopic view was giving way as German companies were forced to compete for international investors' capital.
