Two for the Road
This trip has made one thing clear, the streets of a country's cities and towns tell far more about economic success than do the pages of the nation's annual budget report.
Consider Italy, where I immediately was struck by a vibrancy I'd not found during other visits. As Paige and I drove acoss the country, passing through Milan and Pisa and Florence on our way down to Rome, we marveled at Italy's incredible infrastructure. Despite its mountainous terrain, the powers that be have wisely created scores of tunnels that help drivers pass effortlessly through the rugged region.
That same dynamism blanketed France where we saw public works projects -- buildings being erected, roads being repaired, bridges being built -- in every town on our way north from Bordeaux to Paris. In Rome, every monument and museum was being renovated or cleaned. In Paris, the stores were crowded with shoppers.
In fact, Paris had the highest concentration of high-end shops we've seen yet. For once, we had no trouble getting connected to the Internet, a pleasure we haven't always enjoyed on our journey.
The indications of prosperity really hit home when we were in Florence visiting Uffizi, the former offices for the Medici family, which ruled Florence from the 1400s through the 1700s. (It's now a gallery which houses some of the world's most famous Italian renaissance artwork, including Boticelli's Birth of Venus.)
The square in front of the Uffizi is littered with street vendors, Senegalese merchants selling counterfeit products from handbags to wallets to clothing. These merchants boast only the finest brand-named knock offs, from Fendi to Prada to Gucci. We were really surprised by the quality and craftsmanship of these counterfeit items, most of which were so well done we were hard pressed to tell they were counterfeit at all.
So why did that strike me as a measure of the country's success? It made me think Italy is producing some very high quality products right now, good enough that even the fakes look impressive. Throughout our trip, Paige and I have seen our fair share of knock offs, in Korea, Japan, and Siberia, for instance, and the ones we encountered in Italy were the finest we've seen so far, hands down.
Does that mean I am rushing to invest Italy and France? Cautiously at best. Faithful readers of my columns will know I've often been down on both countries. Italy, after all, is one of the most indebted countries in the world. I'm willing to forgive such debt if its for productive capacities, such as roads and tunnels and public works, things that ultimately produce a return. Heavy debt, though, is a burden that becomes more and more difficult to bear. (Just take a look at the U.S. debt). Italy was forced to deal with its fiscal imbalances last year in order to gain entry into the common market but I'd wager a guess there was as much creative bookkeeping going on as there was real repair work done to the economy. Inflation sits at the cusp of the 2 percent limit of the Maastricht treaty and unemployment, at about 11 percent, is astonishingly high.
France's economy is in a little better shape, despite an unemployment rate over 10 percent. Still, I'm convinced its socialist system with its absurd labor laws and overly generous social welfare benefits forever strangle any long-term growth. I've always characterized the French as paper-pushing bureaucrats and even on this trip, they haven't proved to me they've changed very much. Take the moment Paige and arrived at the English Channel tunnel prepared to go to England. We were getting ready to board our car onto the recently completed Chunnel train, when we were stopped short by French bureaucracy in action. Here's why: In order to ensure we always have enough fuel, we carry three five-gallon jerry cans filled with diesel. Understandably, the French did not want us to carry the can through the tunnel, even though diesel is much less dangerous than traditional fuel. (They will let you take a 10-liter can filled with gas through but not three five-liter cans half filled. Go figure.) To accommodate the authorities, we dumped the diesel into our gas tank and prepared to make our crossing. "Not so fast," the boss, a man named Monsieur Bohler, told us. He insisted the cans be filled with water in order for it to be safe. In the end, it took six men plus two trucks to fill our three jerry cans with water. That's French taxpayer dollars going to work. And that's French bureaucracy at its worst.
Still, street fairs aren't the only proof the French and Italian economies are better than I had imagined. The numbers speak loudly, too. The stock markets in France and Italy were on a tear through most of 1999. The CAC 40 in Paris was up 51.1 percent. The MIBTEL in Milan was up 22.3 percent. Look at their trade balances, a measure of how competitive an economy really is in the global market. Both countries have been running trade surpluses for years -- France since 1992, Italy since 1993. Despite all the talk of our new economy in the U.S., we've been uncompetitive for more than 25 years, running a significant trade deficit.
The big question for me, though, is how have these countries achieved such prosperity and whether it is sustainable. A trade surplus clearly suggests they are doing something right but I also believe other forces are in play.
On a simple level, I believe the emergence of the European common market has had a great deal to do with their success. With 11 countries essentially supporting one another, countries like Italy and France have prospered in areas where they suffered in the past. French and Italian farmers, for instance, have been collecting agricultural subsidies, not only from their own citizenry, but also from the other countries in the common market. France, after all, is the leading agricultural producer in Western Europe, exporting wheat and dairy products and these subsidies are a tremendous help to its farmers. (I wonder, though, how long, say, German taxpayers will contentedly pay money to French farmers.)
The establishment of the Euro, the single currency, has also been a boon to these two countries. When the European Community put together the rates for the Euro, each country joined at certain and set exchange rate. The Italians were fortunate enough to join at a fairly low rate, helping to keep the Italian market competitive. Essentially, any EC citizen travelling through Italy can stretch his Euro dollar much further in Italy, which has made Italy particularly competitive over the past year. Similarly, the Euro has been favorably priced globally, down over the past year relative to the dollar and the yen. That's helped keep both countries highly competitive as well.
And although the so-called Y2K bug turned out to be as destructive as a summer breeze, the expanding money supply it created has been a significant boost to the economies, particularly the stock markets. Here's how: Central banks of countries like France and Italy prepared for potential Y2k problems by boosting the money supply, effectively printing more and more currency and making it easier to get credit to inject liquidity into the marketplace and cushion the blow associated with any Y2K problems. The same thing was going on almost everywhere, including the U.S. where Mr. Greenspan let the presses run off more money at the highest rate since World War II.
Such a surplus of money naturally finds its way into the stock market, boosting prices and further feeding the bull market. In fact, both the CAC and MIBTEL exchanges made their biggest gains in the fourth quarter, when the central banks left the money-supply spigots wide open. While such an artificial boost concerns me, I am more worried about how the central banks intend to soak up the extra liquidity which is on the market and what may happen if they don't do it successfully. If they cut back too quickly, constraining liquidity, the resulting sell-off could be devastating to the French and Italian markets. By contrast, if they act too slowly, the excess money could create inflation.
In fact, the France's just-released December figures project an annual inflation rate of more than 5 percent unless something is done. The guidelines of the EC have pretty strict rules about proper inflation levels and neither of these countries want to start trouble with Brussels.
The European central bank has already announced it plans to return to a 'normal' money supply now that Y2K is over. Reaching those levels will require fairly substantial reductions. Already, the markets in France and Italy have reacted: the CAC 40 was down 5.2 percent year to date as of Jan. 10, the Italiantkexchange down 6.6 percent. I hope the central banks are sophisticated enough to handle this without creating too much of a problem, one that could resonate beyond the markets and into the greater economies of these countries. We'll have to wait and see but it shouldn't be ignored.
Over the longer term, investors should be aware of other dangers. Both Italy and France have a demographic problem: an aging population. Every bar or restaurant or shopping area we visited was dominated by older people, quite a contrast from countries like Turkey or Ireland or Iceland or Korea where we saw young people everywhere.
Estimates put population growth at negative 0.08 percent for 1999. In fact, Italy has one of the lowest birth rates in the world right now, standing at only 1.22 children born for every woman. At that rate, the country won't even be able to reproduce its own population. There may not even be any Italians left in a few decades. France has a less dire problem -- a birth rate of 1.61 children per woman -- but the aging population was evident.
In turn, both countries' pension funds are feeling the strain. Without a labor force to infuse new money, the pensions are going to dry up long before a new generation of working Italians and French arrive to replenish the fund. Both countries, but particularly Italy, will have to ease their labor restrictions, opening their borders to foreign labor, like workers from Turkey and Ireland, to ensure the pension funds do not fall apart.
The entire EC faces another long-term problem. I've said it before but I'll say it again: I just don't believe the Euro can succeed. Sure, it's a great thing. The world needs a Euro. But it's badly conceived. You simply can't put 11 countries together unless they all have the same economic fundamentals. And while all the common market members claimed to have the same fundamentals, everyone knows many of the countries used phony numbers and massaged the books in order to appear fiscally prepared. Naturally, seeing what these countries have covered up is difficult, especially in the midst of a bull market. But if and when a downturn comes, I think you'll see a lot of skeletons rattling out of the closets. And don't forget: Six new countries from central Europe are applying for entrance into the common market. These small nations are working overtime to make their economies 'appear' fiscally sound. But unless the economic fundamentals are the same across the board, this united currency of Europe is just doomed to fail.
Despite all these potential problems, some industries will prosper regardless. I've owned a few French companies for a while now and although I don't own any Italian companies, I'm keeping my eyes open for good opportunities. During our trip, I've become keenly aware of forces that could make certain industries particularly lucrative in the future. Here are a few themes I think could be very profitable.
Banking. Just as the banking industry in the U.S. has merged, I believe the European banking industry is poised for rapid consolidation over the next few years. In particular, I've been trying to find small banks in Italy and France that will inevitably be taken over by one of the larger players in the European Community. While I have picked up banks in other parts of Europe, I am waiting for a setback here.
Defense and aerospace. Defense spending is on the rise worldwide and this industry already has been consolidating throughout Europe. With good reason, too. The U.S. defense industry is well ahead in the merger game and the European governments and defense and aerospace industry players have awakened to the fact that in order to compete, they must join forces. This is a rare opportunity: How often does a government intervene to encourage an industry to consolidate? More often than not, governments fight the creation of such industry behemoths in anti-trust suits. I've owned Thomson CFS, a French aerospace company, for a while and plan on holding on to it. I am looking for an opportunity to buy more.
Note: Many countries would rather buy airplanes and radar systems from the Europeans than the Americans anyway. Our U.S. state department has a nasty habit of cutting a country off if it becomes dissatisfied with its interests or actions. In fact, I have heard many stories about countries actually paying for airplanes up front only to never receive the goods because they fall out of favor with our government. They don't even get their money back. With business practices like that, it's no surprise many foreign countries are looking elsewhere to do business.
Brand name consumer goods companies: With the economies in Europe and Asia starting to bustle again, companies that produce recognizable products are often in demand. I own Christian Dior, a company which manufactures everything from cologne to skin-care products to perfume. In boom times, consumers tend to seek out such brand names. In an economic downturn, of course, these investments are among the first to suffer, but as the Asian and European economies continue to recover, they should do well.
Resorts. Economic boom times tend to encourage more travel and vacation planning. That's made resorts in Italy and France a good bet. I own a company called Cie des Alpes, a French company that not only has a number of ski resorts around the country but also a wealth of unexploited real-estate holdings. As the demand for ski resorts continues (and the lines at the lifts continue to grow), this company will expand and tap some of those choice opportunities.
Natural Resources. To tell you the truth, Europe doesn't have that many natural resource plays. The few that do exist, though, have taken a beating during the past few years. I own Metaleurop, a metals company in France. While the stock has fallen in the past two years, I'm fairly optimistic about its future.
Most often, when you speak of natural resources companies in Italy and France, people assume you are talking about oil and gas companies. I've owned TotalFina for quite a while now and I think it could be the next international major, up in the big leagues with ExxonMobil and RoyalDutch. I also have bought some ENI in Italy. With oil prices hovering around $25, I'm not sure I would tell anyone to buy it right now. A set back in the price of oil, however, could open up a great buying opportunity.
Think about it: Companies like TotalFina have a tremendous advantage over some of the major U.S. oil companies because our state department won't let American companies do business in a lot of countries. (Not to mention, that many countries just don't trust American oil and gas firms.) The Europeans don't have that problem. They are willing to do business with oil tycoons in Libya or Nigeria or Iran or Iraq. For such European oil and gas firms, it's like getting a free lunch: these companies do big business without having to compete with American companies. I think almost any oil company you can buy in Italy or France could benefit.
Clearly, even with my concerns over the growth in the money supply and the fate of the Euro and common market, Italy and France offer some good places to invest. It's important to remember that, unlike the U.S., the public in Europe is not nearly as market savvy or as invested in the stock market. That may change if the European economy continues to recover. If per-capita investment levels ever reach anything near what we have in the U.S., Europeans could see a bull market for many years to come. We all should be aware of such a potential opportunity.
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