Soothing Sensibility Sees Silver Lining in Europe

In these times of bad debt, imploding currencies, and swan-diving stock markets, a jumpy world might benefit from a dash of soothing, Old World sensibility.

Meet James Seddon.

Mr. Seddon manages the $1.5 billion T. Rowe Price European Stock Fund. His portfolio steadily ranks at the top of its class, having returned an annual average of 20 percent over the past three years.

But ogling European stocks today is like admiring Paris during a wartime siege. European equity markets have cascaded along with Wall Street in recent months, plummeting 17 percent since July, according to a Dow Jones regional index.

But beneath the storm, Europe shines brighter - or glowers less - than any other region on the basis of risk and return. Its stocks are comparatively cheap, especially amid the current correction.

And the launch next January of a common regional currency - the euro - will whip up a whirlwind of cross-border mergers and investment, equity analysts say.

"If you look around the world, [Europe] stacks up well compared to other regions," says Mr. Seddon.

His return this year suggests that the region offers a latent upside: Despite the recent slump, European equities have risen 11.6 percent for the year (as of Oct. 23), far ahead of any other region. Indeed, amid today's global stock market slump, no other region promises more gain.

Seddon looks beyond the region's Jekyll and Hyde personality by focusing on company fundamentals. He visits several firms each year, steering clear of cyclical stocks, such as airlines, and buying companies at a reasonable price with a promise for sustained growth. Equities with high price-to-earnings ratios do not deter him as long as their earnings are rising strongly.

Still, Seddon says investors can't ignore the broad market milieu.

In Europe, as elsewhere, it's not all pretty:

Economists are marking down growth estimates, clipping the wings of Europe's recovery. Morgan Stanley Dean Witter recently cut estimates for regional growth this year from 2.7 percent to 2.2 percent.

In turn, earnings estimates are waning. Alcatel, the French telecommunications giant, and Royal Dutch/Shell Group rocked markets in September by cutting profit expectations.

Europe has far to go in reforming its labor laws, which limit corporate leeway in paying and firing workers. Such limits keep business costs high and hurt competitiveness.

Friction will probably arise among the 11 nations planning to hand over much of their economic sovereignty to the European Union. For example, the EU central bank might disregard the call for lower interest rates from countries troubled by rising joblessness or recession.

Businesses and analysts underestimate Europe's exposure to the recession spreading from East Asia to emerging markets elsewhere. Indeed, European banks at the end of last year held $415 billion in emerging-market debt, or nearly four times that of the United States, according to the Bureau of International Settlements.

Still, Seddon remains optimistic. "The United States is probably keener than the Europeans to cut rates, but I expect they will all do the right thing," he says.

Seddon expects Europe's markets will spring back, with the region's advantages.

When the common currency is fully phased in by 2002, Europe will stand as a single market of 290 million people, generating 19 percent of world output.

Already, corporations are merging and streamlining to exploit the fall of national barriers to business and investment.

"You have seen restructuring in the US in the past decade, and it has gathered momentum in Europe," says Seddon. "As they restructure, it will be easier for European companies to generate higher returns than for US companies."

Also, to meet the terms of economic union, Spain, Italy, and other chronic high-debt governments have slashed public spending and borrowing, thereby spurring an invigorating fall in interest rates.

Finally, declining interest rates have pushed Europeans into stocks and away from government bonds as never before.

Among Seddon's favorite stocks: Wolters Kluer, a Dutch publisher with a strong franchise and steady growth.

He also likes French food company Danone, Royal Dutch/Shell, British drinks conglomerate Diageo, and Unilever, whose stock price dropped recently as demand in emerging markets fell.