Ripples, but no panic for Europe's investors

It’s a minefield out there for European investors lately. First, in March, the hyped-up Amsterdam flotation of free Internet service provider World Online – the biggest Internet initial public offering ever in Europe – wound up in a 60% share price collapse. Thousands of small investors across Europe lost big-time, including hundreds of World Online employees. And since a peak in early March, Europe’s high-flying Nasdaq clones such as Frankfurt’s Neuer Markt and Paris’ Nouveau Marche have plummeted by as much as 35%. Meanwhile, Europeans watched with horror as Wall Street haemorrhaged over $2 trillion in losses in a five-day period ended on 14 April.

Such shocks could be enough to turn anybody off equity markets, especially in Europe, where putting money in stocks still has a whiff of the exotic, if not the downright sinful. But don’t look for Europeans to beat a permanent retreat from their local bourses. The signs are that popular capitalism on the Continent will more than just survive its first test of market turmoil. One clear indication was the Apr. 17 $3bn flotation of 9.4% of Germany’s T-Online. Launched in the wake of Nasdaq’s collapse the previous Friday, it came off without a hitch, netting many first-time punters 39% on the first day of trading.

Young hopefuls
The offering’s success reflects a remarkable change in attitude in Europe. The steady shift into equities may be of recent vintage, but its underpinnings are substantial. That means investors are unlikely to flee at the first sign of trouble, even as they become more discriminating. Europe now has a bunch of younger investors eager to grab some of the rich gains possible in the stock market. Institutional investors, too, are looking for fatter returns. And governments will depend on the markets to overcome shortfalls in state-funded pension plans.

The change of attitude is in large part a change of generations. Unlike their parents, younger Europeans have little experience of inflation and are now spurning low-yielding bank accounts and bonds for assets with better returns. At the same time, the slow but steady dismantling of social security and health services under way in various degrees across Europe means younger Germans, French, and Italians are having to think about private schemes, increasingly financed by equity investments. ‘The result is a massive, iceberg-like asset shift from bank deposits into stocks,’ says J.Paul Horne, chief European economist at Salomon Smith Barney in London. Adds Jean-Francois Theodore, chairman and CEO of the Paris Bourse: ‘As long as people believe the markets are rational, the equity culture will continue to develop.’

At the same time, pressure is mounting on European governments to defuse the looming pension time bomb. Most state pension schemes are largely funded by taxes. But with Europeans living longer and having fewer children, there aren’t enough active taxpayers to foot the bill. ‘The only viable long-term solution is to switch the funding of pensions away from taxation to investments in the stock market,?’ says Ann-Kristin Achleitner, finance professor at the European Business School outside Weisbaden. ‘That’s why the long-term trend toward the equity culture won’t be reversed.’

No wonder Continental institutional investors are increasingly interested in buying equities rather than bonds: Despite recent volatility, the long-term returns are higher. That’s especially true now that Europe has a single currency and interest rates are near historic lows. ‘These people aren’t going to be deterred by recent sell-offs. They are aware that equities aren’t bonds and that they can go down,’ says Carlo Monticelli, co-head of European economics at Deutsche Bank.

The numbers are impressive. Last year, for example, net inflows into German equity mutual funds reached $196bn, over twice the level of the year before and surpassing inflows into bond funds for the first time in German post-war history. In Italy, the shift of savings out of low-yielding government paper into equity funds has been even more impressive. Over the last three years, the value of Italian equity funds has more than tripled, to $475bn. And studies in France indicate that the ranks of individual investors may have swelled by as much as 40% over the last two years.

A boom in share buying of this magnitude has led to overvaluations ? and to U.S-style hype never before seen around the Continent. The Brussels-based Easdaq market of European small-cap stocks sports a dizzying average price-earning ratio of over 500. In France, thousands of billboard ads for online broker Selftrade.com feature diamond-encrusted, solid-gold hammer and sickles. The message: ‘What if getting rich was for everybody?’

Yet despite the implosion of World Online and other Net-related European outfits, individual investors in Hamburg or Madrid are still much less exposed to overvalued tech shares than their American counterparts. Partially, that’s because of Europe’s slowness in jumping on the Internet express. The Continent not only has few Web pioneers like Yahoo! Inc. and Cisco Systems Inc. but also a leaner IPO stream. In all the major indices of European shares, from Paris’ CAC to Frankfurt’s DAX, technology stocks are much less represented than in comparable U.S. indices. Hence, the DAX is down just 5% over the last month.

To be sure, the recent chaos in the markets has caused some European high-tech IPOs, such as prominent Dutch broadband Internet service provider Chello, to be postponed. Italy’s high- flying Tiscali, one of last year’s hottest IPO’s, has had to shelve a secondary, $480m offering.

Quick education
However, the turmoil now is probably more informative than terrifying. ‘This downturn is going to educate people faster about valuations, but it won’t remove the trend,’ says Nicolas Gaume, CEO of the game-software-development outfit Kalisto, whose own IPO created a score of millionaires at the small Bordeaux-based company.

It will take more than a mere correction to slow down that locomotive. As in the U.S., where mass stock ownership helped the Democratic Party move toward the political centre in the 1980s and early 1990s, the extension of popular capitalism in Europe is likely to lead to growing support for low taxes and business-friendly policies. That possibility has not been lost on some left-wing European leaders, such as German Chancellor Gerhard Schroder, who has been slashing taxes and calling for workers to invest. France’s Prime Minister Lionel Jospin, a more diehard socialist who has backtracked on privatising the country’s pension system, is now readying measures to boost stock ownership, according to aides. After all, he could use the votes of investors if he runs for the French presidency in 2002.

By John Rossant in Paris with David Fairlamb in Frankfurt
This article first appeared in Business Week magazine.