Searching for bargains in European markets

OVER the past few months, Family Money has stressed the importance of investing in the surrounding Asian Pacific markets - excluding Japan - because the upward momentum of these bourses offers investors promising returns without excessive risk.

We have also pointed out the benefits of getting into emerging markets such as South America, Mexico, India and Indonesia because their volatility, combined with their rapid development, gives investors a good opportunity to diversify their portfolio with an inherently risky, but high-return investment.

By putting together a well-spread portfolio, comprising funds from these two beckoning market categories, investors can expect attractive benefits over the long term.

Amid all the excitement, the media has forgotten the European markets, brushing them off as stagnant and unfashionable. But have they really run dry, or is it merely a case of the market's fickle sentiment? Well, a quick glance at global interest rates makes it clearly apparent that there are still some hefty gains to be squeezed out of Europe's markets.

First to come to mind is Japan, which shocked the international finance world on Monday with its 0.75 per cent official discount rate cut taking interest rates down to a record low of 1.75.

American interest rates are not too far behind at four per cent and Hong Kong is even closer as its figures tend to fall a little under US ones.

These are in sharp contrast with European rates, which are still hovering around the seven per cent mark.

Presently, France's rate is set at 6.8 per cent, Germany's is just under at 6.25 per cent, while Britain is the lowest in Europe at six per cent.

''It is inevitable. If Europe wants to have the type of recovery that America is working towards, it is going to have to drop its rates to around four, if not three per cent.

''Those who get in now can benefit by riding the market up as interest rates are cut,'' said Richard Harris, manager for Jardine Fleming Investment Management.

Mr Harris stresses that investors who jump in now can benefit particularly from the method Europe will use to cut its rates.

''We already know interest rates have to come down substantially and will continue to decline, but, more important, is how they will fall.'' Mr Harris expects to see interest rates come down in a step-by-step fashion, ''little-by-little''.

He says the manner of ''drawing out'' the whole rate cutting process creates a strong element of anticipation, which fuels market optimism.

While cutting rates from seven to three per cent will send a market soaring, Mr Harris stresses this will be an isolated incident.

''Europe has already set a trend, interest rates have come down from around eight per cent, but this has happened very slowly. It has been deferred for so long, everyone has been anticipating and forecasting cuts for about three years,'' he said.

Because it is still a long way to go before the forecasted three per cent mark is reached, investors are strung along while anticipating the next drop. Sentiment is boosted with each announced cut and this pushes the market up.

''That is why it is essential to get in now and ride the market through its slow climb up. In this kind of scenario, it is much better to travel than to arrive,'' Mr Harris said.

Most analysts see the collapse of the Exchange Rate Mechanism (ERM) as the catalyst to trigger in the decline of interest rates and most expect it will take between 12 and 18 months for interest rates to bottom out.

While many advise investors to consider European markets only when diversification, some actually expect Europe to surpass Asian markets.

''The estimated growth rate for Asian markets has come down for starters. Investors should be aware of this and keep in mind that the markets hit hardest are always the strongest to bounce back.

''It is foreseeable that the European markets will outperform the Asian ones in the shorter term,'' Mr Harris said.

The European markets, however, should not be clumped into one as some hold more potential than others.

For example, common sentiment is that Germany's growth should be minimal if not inexistent, leaving analysts rather bearish.

''Actually, we're expecting German interest rates to come down much slower than the other markets, meaning practically no growth. Consequently, we expect only a 1.8 per cent yield in 1993 and an even smaller 1.5 per cent yield in 1994,'' Mr Harris said.

He points out that Germany's market plays an important role in the EC as it provide a kind of benchmark.

Micropal charts illustrating the various indexes show that, over the past year, the European markets have converged towards Germany's bourse, much in line with the ''single market economy'' concept.

This convergence is essential as it brings lower inflationary growth, which means higher P/E ratios: lower inflationary growth means real earnings.

As for Britain, short-term investment looks extremely promising as many expect a double recovery.

''We believe Britain has been moving into more of a low growth, low inflation economy because of the EC's convergence. Britain should recover twice - once along with the US recovery, and a second time along with the European recovery,'' Mr Harris said.

Expected yields from British market are 4.1 per cent in 1993 and 4.3 per cent for 1994, with a P/E ratio expected at 16 and 13 for 1993 and 1994, respectively.

France is next in line for high ''recovery returns'', according to Jardine Fleming's investment team, with a 2.9 and 1.5 per cent yield forecast for 1993 and 1994, respectively, along with P/E ratios set at 25 for 1993 and 18 for 1994.

Mr Harris said investors interested in a European unit trust should see the majority of their money go into Britain/Ireland trusts and bonds, a smaller amount going towards France, Switzerland, Holland, Italy, Spain and Belgium as a single market, spreading a very minimal amount over German and Austrian markets.

But, while European markets promise an attractive six-month to one-year investment, those looking for a long-term investment should stick with Asian Pacific markets as the potential returns generated from Europe's recovery should not surpass the long-term returns from Asia's growth potential.