The euro is staging a comeback.
After falling by up to 13.6% of its peak against the U.S. dollar when introduced Jan. 4, the infant currency appears to be at a turning point.
Strong economic data from Germany last week, combined with the expected slowing of the U.S. economy, plus a fillip from the apparent end of the Kosovo crisis, are contributing to the euro's initial steps toward recovery. In response, the currency bounced back from a low of $1.026 June 7 to $1.049 June 10.
"We think 1.02 euros to the dollar is the bottom. We think it will be at 1.15" by year-end, said Adrian Paine, chief investment director at American Express Asset Management, London.
"We're going to get a very sharp reversal," he added.
Echoed Bob McKee, chief economist at Independent Strategy Ltd., London: "We're very positive and optimistic about a big upturn in the core of Europe. We could see growth of 3%" next year.
Still, some skeptics warned euroland must face its long-term structural issues, or the currency might prove to be more like the Italian lira than the German mark.
But even a short-term rebound is good news for investors in euroland stocks, which have taken a bath from the euro's weak showing.
In U.S. dollar terms, euroland stocks had lost 6.24% of their value through June 7, before the currency's bounce, although the euro index returned a positive 6.93% in local currency terms, according to Morgan Stanley Capital International, New York.
In contrast, the Standard & Poor's 500 stock index gained 8.6% during the same time period.
While newspaper reports have pounded the euro's weak performance, money managers believe the worst might be behind the new currency, and prospects for a rebound this year and next are significant.
The story of the euro's disappointing performance this year, managers said, is relatively simple: Euroland experienced surprisingly poor economic performance while the U.S. economy took off, well exceeding expectations.
In particular, Germany and Italy have teetered on the edge of a technical recession. In contrast, U.S. economic growth has hovered around 4%.
"What's beat up on the euro has been disappointments in growth," said Andrew Snowball, senior economist at Julius Baer Investments Ltd., London.
Perceptions of a weakening euro were exacerbated by a series of events. These twists and turns, however, affected the currency's value only marginally, observers said. They included:
* Former German Finance Minister Oskar Lafontaine's antipathy to structural reform and his calls on the European Central Bank to lower its refinancing rate upset investors. Mr. Lafontaine since has resigned and been replaced by the pro-business Hans Eichel.
* The Kosovo conflict affected consumer and investor sentiment, particularly in Italy.
* European central bankers sent confusing signals over the desired exchange rate for the euro, and the European Central Bank wasn't willing to intervene.
* Euroland nations agreed last month to allow Italy to raise its target deficit for 1999 to 2.4% from 2%. Investors feared the stabilization pact -- requiring that annual deficits remain lower than 3% -- would be disbanded.
Still, managers estimate at least two-thirds of the currency's decline from its Jan. 4 peak of $1.1877 stemmed from deteriorating economic conditions.
A recovery in Germany?
Weakness in the euro, however, finally might be helping German industrial companies boost their exports. Last week, Germany -- which accounts for one-third of euroland's economy -- revealed gross domestic product gained 0.4% in the first quarter, after a 0.1% drop in the last quarter of 1998.
What's more, German manufacturers reported a 2.2% boost in orders in April, driven heavily by export demand. A recovery in Asia and other emerging markets is helping Europe get out of its lethargy.
Plus, comments by Bundesbank President-designate Ernst Welteke that the appropriate exchange rate should be $1.08, buoyed the euro.
Meanwhile, a strong U.S. dollar -- which will rise further if the Federal Reserve raises interest rates as expected -- might hurt U.S. exports.
"At some point, over the next six months, we should see positive growth surprises out of Europe and the opposite in the U.S.," said Tim O'Dell, a fund manager who is responsible for developed foreign exchange markets at Investec Guinness Flight Global Asset Management Ltd., London.
Managers said economic growth of only 1% in the first quarter should change rapidly, with annual growth for 1999 coming in at 2% to 2.5%, and higher in 2000.
Risk is still there
The risk is that the stocks will follow Wall Street, said Leon Cornelissen, senior strategist for the Robeco Groep, Rotterdam, Netherlands. "If we see a correction (in the United States), perhaps triggered by the Fed, and a weakening of the American economy, then I have problems seeing a recovery in euroland," he added.
Said Riccardo Ricciardi, chief investment officer, global products at INVESCO Asset Management Ltd., London: "I would not be surprised by a (U.S.) correction within the next three months," on the order of a 20% drop.
What's more, if the yen depreciates, it would drag down the euro, he said. "If you want to buy euros, my advice would be wait."
Some questioned whether Germany has turned the corner. Gabriel Stein, senior international economist at Lombard Street Research, London, said the latest German data suggest a 10% annual rate for domestic demand growth, which is unrealistically high.
German "growth will continue to be quite weak through the end of this year and possibly going into 2000," he said. This is bad news for peripheral euroland, including Spain, Portugal and Ireland, whose economies are starting to overheat with the central bank's low-interest rate policy, he said.
European portfolio shifts
Nevertheless, some managers have been rejiggering their European equity portfolios in anticipation of a reviving economy.
Jamie Sandison, head of the European team at Edinburgh Fund Managers PLC in Scotland, said the firm has tilted toward stocks that are more economically sensitive, such as Thyssen AG, DaimlerChrysler AG, Saint-Gobain and DSM NV.
Meanwhile, Edinburgh has sold off telecom stocks Swisscom AG and Deutsche Telekom and utilities Union Electrica Fenosa SA and Suez Lyonnaise des Eaux. It also has reduced holdings in pharmaceutical companies, such as Novartis AG and Roche Holding AG.
Similarly, American Express Asset Management shifted to electronics stocks at the beginning of the year, building new positions in STMicroelectronics NV and Philips Electronics NV and increasing General Electric Company PLC and Telefonaktiebolaget LM Ericsson, Mr. Paine said. The manager also is overweight in oils and banks. Last week, managers decided to boost their allocation to European stocks.
Still structural issues
Longer term, managers maintained, Europe must come to grips with its rigid labor markets, bloated bureaucracies, market constraints and unfunded state pension problems.
These "substantial structural problems, combined with an unwillingness to tackle them, and another problem -- the demographic issue -- will strike Germany and Italy quite badly," said Lombard Street's Mr. Stein.
Alan Brown, global chief investment officer for State Street Global Advisors, London, said the implications are threefold:
* Monetary union requires a bigger European union budget to iron out deficits. "It's dangerous to have Ireland growing at 8% and Germany close to zero," he said.
* A much more powerful and democratic government is required at the center. But it's unlikely national governments would cede more authority and sovereignty to Brussels.
* Labor markets must be much more flexible, allowing employers to hire and fire and change pay practices.
If those changes don't happen, the euro's recent troubles in a fairly benign economic period could be multiplied in a worse economic climate, Mr. Brown said.