Europe's equity markets, some of which warmed up at summer's end, just might keep on rising, some analysts predict. And continued strength could cause waves in international equity allocations by U.S. institutions.
"The next big shift in global equity allocation will be away from the U.S. market and towards all other international markets, with Europe receiving at least a proportionate share" of close to 60% on non-U.S. capitalization, wrote Mark Howdle, European equity strategist with Salomon Smith Barney Inc., London, in Salomon's equity research report titled "European Portfolio Strategist."
"Long-term U.S. investors such as pension funds and insurance companies are under some pressure from industry consultants and fund trustees to gradually build up foreign equities' share of total assets," he wrote.
The combination of the U.S. market delivering low returns and a weak U.S. dollar would push U.S. investors to increase allocations to foreign equities, he said.
Typically, institutional investors such as pension funds and insurance companies have 7% to 10% of assets in international equities. That could shift to a long-term target level of 15% to 20% and perhaps higher.
A hot August
Without a doubt, European markets were warming up in August. The Morgan Stanley Capital International Euro index, which includes developed markets in Europe, was up 2.2% in August, while falling back 0.6% in September.
But the macroeconomic picture for Europe looks good, one analyst said.
The events of August and September signal "a period of boom-like growth lies ahead" for Europe, said David Mackie, an economist with J.P. Morgan & Co. in London. For example, demand across Europe for durable goods is accelerating, he said.
Growth in gross domestic product across Europe could rise by 4% over the next 12 months, Mr. Mackie wrote in a report titled "European Economic Outlook, October and November, 1999."
More good news is to come. He expects unemployment in Europe to reach its lowest levels in nearly two decades, falling to 8% over the coming years.
And inflation will remain below 1.5%, they predict.
4th quarter will be tricky
Europe's rise is "only the start of a longer phase of outperformance," wrote Salomon's Mr. Howdle. With the euro stabilizing, foreign investors are more likely to buy heavily into European markets over the next year or two.
But investors might just have to wait for the good times, he warned. "The final quarter of the 1900s will be tricky." he wrote.
During the fourth quarter, European markets could be trendless and volatile, and experience increasingly illiquid market conditions, he warned.
"Pre-millennial tension is likely to give way to a post-millennial relief rally," he added.
But Europe isn't the only story in the fourth quarter and beyond, others argue. While upbeat about Europe's prospects, especially in technology stocks, a couple of portfolio managers looking for earnings growth are going to continue overweighting Japan in their portfolios.
Both Driehaus Capital Management Inc., Chicago, and Sit Investment Associates Inc., Minneapolis, are currently overweight in Japan and underweight in Europe in their international equity portfolios. Driehaus has a 27% weighting while Sit is 30%. The MSCI Europe Australasia Far East index currently has a 25% weighting in Japanese stocks.
Japan opens up
Japan's government and economy are headed in the right direction, said Roger Sit, deputy chief investment officer, international portfolio manager at Sit Investment. The government is making it easier for foreign companies such as France's Renault SA, which bought a chunk of Nissan Motor Co. Ltd. earlier this year, to invest, he said. Recent bank consolidations and the new presence of foreign brokerages are further proof of changes in Japan.
He likes Europe,but recent mixed economic numbers signal "things are getting better, but not at a robust pace." Germany's level of unemployment, for example, is still high at close to 11%.
Sit runs a $700 million active EAFE-style portfolio for institutional investors.
"Japan continues to be our favorite," said William Andersen, senior vice president and portfolio manager with Driehaus. He is likely to increase the Japan weighting in the portfolio before the end of the year.
Driehaus manages close to $1.5 billion for institutional clients in its active EAFE portfolio.
He's looking for fast-growing, midsized companies with high-tech bents. Goodwill Group Inc., a Tokyo-based temporary employment firm that has expanded into information technology consulting, and Hikari Tsushin Inc., a Tokyo-based franchiser of electronics stores, are two, he said.