P&I: Where are you seeing most of those companies in particular?
MR. MCKENZIE: Some in Germany - mainly in Germany at the moment - one or two in France. On the quality stock-picking side, we have found some very good French stocks. We have dabbled in parts of emerging Europe. We have been in Hungary and Croatia for our core European funds.
The place where we are finding it relatively less easy to find good quality growth stocks at good valuations is U.K. So, relative to its market weighting, we are way underweighted in the U.K. in our European fund for U.S. sponsor clients.
P&I: Nilly, let us go to you next. How do you feel about European stocks? Where are the best values?
MS. SIKORSKY: We believe in the restructuring concept. There is enormous potential for equities in Europe via the formation of pension funds, and every institution being too low in equities and too high in bonds and gradually changing that.
P&I: Allan, what do you think?
MR. MCKENZIE: I would agree with what Nilly said, but I think it is quite a longer-term game plan in terms of its movement from bonds toward equities. It may not be until we get to the next millennium when we really will get a meaningful move.
But I would agree with what Alan said in terms of the opportunities that lie at the stock level. Our approach in Europe is to really ignore country level allocation and come in very much at the stock level. I think we have historically been very cynical about protestations of a move toward shareholder value in Europe, but we continue to see good opportunities in the restructuring area.
P&I: Tony, your views?
MR. THOMSON: I do not quite share the enthusiasm, but I have somewhat the same approach to Europe. If you look at it top-down, it looks like a mass of all sorts of negatives associated with EMU. But then you start looking at individual companies and I would cite, for example, our Hypo Bank - no, I have no shares in Hypo Bank personally - but they actually are restructuring in what I think is quite a rational way, given the constraints of Germany and they have a union within the bank and so forth. I can make a case for investing in many of the markets in Europe on a stock-by-stock basis.
P&I: How about the U.K.?
MR. THOMSON: If it was not for the political situation, I would feel very positive. I have lived here since the '60s and I cannot remember a time when conditions have been so favorable. I think if you actually look at the data, it is as good as that of the U.S.
P&I: What is your worry?
MR. THOMSON: Uncertainty more than anything else.
MR. MCKENZIE: It is interesting if you actually go outside the U.K. and talk to people who are looking in rather than inside of the U.K. looking out. You get a totally different perspective.
If you are sitting inside the U.K., it is very easy to be cynical and worry. But the people on the outside - I think the Germans are one of the biggest investors in the U.K., a large percentage of their foreign investment comes into the U.K.; the Koreans, the Japanese. The U.K. economy is the economy of choice and I think that is a great testimony to what is being achieved.
So, obviously, people outside the U.K. have a much higher opinion of the U.K. than, perhaps, people on the inside.
MR. BUCKLEY: Over the next 12 months we are likely to see interest rates rise. There is probably going to be a tightening of fiscal policy if Labor gets in. It is probably the only major market where interest rate expectations actually are worsening today and sterling is strengthening and that is going to cause earnings to be downgraded. Against that kind of background, I just do not see the U.K. performing.
Having said that, it has been a dog over the last month or so, and our valuation models are certainly showing it close to fair value now, having been expensive for quite some time. So I think a lot of the bad news is in the price, but against the fiscal and monetary environment I just do not see it performing.
MR. THOMSON: The U.K. market is basically pension funds; they control it. Pension funds are high in cash and low in U.K. equities. I can think of a number of things that might have an affect on this, because if companies find they have a shortfall, their instincts would be to reduce overseas equities and increase U.K. equities to get more exposure.
MR. BUCKLEY: U.K. pension funds have 55% in U.K. equities. We can argue whether that is high or low in the context of a global portfolio. I would not ascribe to the view that that is low.
P&I: Dean, where are you finding your stocks now in Europe?
MR. BUCKLEY: Like most of the others, we are very positive on Europe. Restructuring is here and we think it is here to stay, and that has been driven by the lower nominal rates of growth that are available today, and also by what we talked about the U.S. today. The U.S. is ultracompetitive and the European economies need to respond to that.
Also, it is interesting to note that equity market capitalization in Europe, as a percent of GDP, is about half of what it is in the U.S. and about a third of what it is here in the U.K. We think over time that is going to change. Governments will be needing to meet the Maastricht targets. They are going to privatize and cut debt. Also, the position of the banks has been weakened and they are going to want to issue stock as well.
So, we think this move toward an equity culture is going to continue and that is going to be supported by continued restructuring. But for the next year or so, I think the key game in town really is EMU and essentially, without growth, EMU will not take place.
We think the interest rate environment within Europe is going to be as supportive to equities as it is anywhere else in the world. We think the stage of the cycle we are at in terms of economic growth coming through, that will also support equity market performance. We think we could see some upward earnings revisions as well with growth coming through and surprising on the upside and also the stronger dollar; that could see some upgrades, particularly in Germany.
So, Germany is the key market that we are focusing on in Europe. Spain is getting cheaper; it looks a little bit better with interest rates falling.
We also like Ireland. Italy has done badly. Risk premiums have risen quite sharply in Italy but we still think the risks are pretty large there. And in the U.K., as you have probably guessed from my earlier comments, we are underweighted. (contd.)
