Learning to live with the Euro
Fleming Asset Management in London gives its views on the state of world markets.
Wednesday, February 17th 1999, 12:00AM
For the financial historians of the future it is likely that the main event of early 1999 will be the launch of the Euro, which on the surface appears to have been accomplished smoothly, with only minor technical glitches. What seems to be becoming clearer is the extent to which portfolio managers delayed adjusting their portfolios prior to the launch of the Euro, and are only now doing so. This will be a long term theme of European and global financial markets, as investors learn to live with the Euro as a reserve currency in competition to the US Dollar, a new Euro liquid bond market, and with pan-European equity portfolios replacing country-based ones.
At the company level, the Euro has hastened Europe-wide price transparency. Competition suggests that convergence will be towards lowest price. This is confirmed by a recent report from the European Commission, which found that price differences for similar cars across the EU had reduced significantly during the second half of 1998. This is yet another factor behind the flood tide of European corporate restructuring and merger activity.
Back in the world of immediate events and crises, Brazil lost its long struggle to control its exchange rate, the Real falling by around 40 per cent during January. Given the centrality of the real plan in policy construction, it is perhaps not surprising that what remains is hard to interpret. Traditionally, giving up an unsupportable fixed exchange rate is supposed to allow short-term interest rates to fall; not rise to 37%, as has been the case in Brazil. The consequence seems likely to be another period of sharp falls in economic activity, exported to the rest of the region and lopping another slice off the growth rate of the world economy which is now down below 2 per cent for 1999. It is not clear whether losing the currency battle will have helped the political system to reform public finances or not. Meanwhile, in Argentina, the government has commissioned a report on whether it should abandon the peso and replace the sovereign currency with the US Dollar. As the Dollar faces stiffer competition from the Euro on the world stage, it seems it may be able to gain additional provinces in Latin America.
Despite fears of renewed financial contagion, the near meltdown in Brazil seems to have worried financial markets relatively little. There is admittedly a growth problem for corporate earnings, but in the US the commodity/manufacturing parts of the American equity market are now a small proportion of market cap. Meanwhile, the service and technology sectors are widely believed to be immune from a profits recession. Good earnings reports from Microsoft, Intel and Dell etc, support for now the hypothesis that genuine fast growth can be accorded exceptional valuations. Similar evidence is harder to find for the Internet stocks, which have been the phenomenon of early 1999.
If Brazil is a noisy and dramatic crisis, Japan is a quiet and grinding one. There does at last seem some indication that fiscal stimulus is finding its way into activity, but there is little optimism that it will generate a self-sustaining recovery by the private sector. In the meantime, the pressure of bond supply is becoming acute, the more so as tax receipts disappoint. Nonetheless, there is an encouraging increase in corporate restructuring stories. If policy and behavioural paralysis was bad, change must be good, even if only in the long term.
This Investment Outlook is provided by Fleming Asset Management, London.
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