Two for the Road

If there’s one thing I’ve discovered on my trip so far it’s that the best indications of a country’s economic success are as visible on the streets of its cities and towns as they are on the pages of its annual budget report. Take what Paige and I recently encountered through our tour of Italy and France. In Italy, I was immediately struck by how much more vibrant and dynamic the country appeared as opposed to every other time I’ve traveled there. As we drove across the country, passing through Milan and Pisa and Florence on our way down to Rome, Paige and I marveled at Italy’s incredible infrastructure: it’s a very mountainous landscape but the powers that be have wisely worked with the terrain, creating scores of tunnels that help drivers pass seamlessly through the rugged region. That same dynamism was present in France where we saw public works projects—buildings being erected, roads being repaired, bridges being built—in every town we passed 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.

All these indications of economic 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.) In the square in front of the Uffizi, there are a number of 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. What really surprised both Paige and I were the quality and craftsmanship of these counterfeit items. They were so well done we were hard pressed to tell that they were counterfeit at all.

So why did that strike me as a measure of the country’s success? It made me think that 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 that I’ve often been down on both countries in the past. 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 that 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 that they have 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 go through the tunnel with cans filled with fuel, despite the fact that diesel is much less dangerous than traditional fuel. (They will let you take a ten liter can filled with gas through but not three five liter cans half filled. Go figure.) To accommodate the authorities that had stopped us, 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 that 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, the proof that the economies of France and Italy are better than I had imagined isn’t just apparent at the street fairs. The proof is in the numbers 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 genuinely how competitive an economy really is in the global market. Both of these countries have been running trade surpluses for years—France since 1992, Italy since 1993—exporting more goods out of their countries than they take in. Despite all the talk of our new economy in the U.S., we’ve been uncompetitive for over 25 years, running a significant trade deficit.

The big question for me, though, is how have these countries achieved such prosperity and whether or not it can be sustained. A trade surplus clearly suggests that these two countries are doing something right but I also believe there are other forces 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 just from their own citizenry, but from the other countries in the common market as well. 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.

More important, though, I believe the growth in the money supply has added a significant boost to the economies, and the stock markets in particular. Here’s how: Despite the fact that the Y2K bug turned out to be as destructive as a summer breeze, central banks of countries like France and Italy prepared for problems relating to the year 2000 bug by boosting the money supply, effectively printing more and more currency and making it easier for people to get credit. This was done in order to inject more liquidity into the marketplace and cushion the blow associated with any Y2K problems. It wasn’t just France and Italy, mind you. The same increase in money supply had been going on in the U.S. prior to the end of the year. In fact, 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 the money supply too quickly, constraining liquidity, a sell-off could result that could be devastating to the French and Italian markets. By contrast, if they are too slow in their actions, the excess money supply in the market could create inflation. In fact the just released December figures for France will lead to an annual rate of over 5 percent inflation 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 that it plans to return to a “normal” money supply now that Y2K is over. Needless to say, that will require fairly substantial cut backs just to return to such normal levels. Already, the markets in France and Italy have reacted: the CAC 40 was down 5.2 percent year to date as of January 10, the Italian exchange down 6.6 percent. I hope the central banks are sophisticated enough to handle this but without creating too much of a problem, one that could resonate beyond the markets and into the greater economies of these countries. That’s something we’ll have to wait and see but it shouldn’t be ignored.

Over the longer term, there are other dangers investors should be aware of before investing in either country. Both Italy and France have a demographic problem: an aging population. Every bar or restaurant or shopping area we went into was dominated by older people. This was quite a change from countries like Turkey or Ireland or Iceland or Korea where we saw young people everywhere. Estimates put the population growth rate 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, they won’t even be able to reproduce their own population. There may not even be any Italians left there in a few decades. France’s has a less dire demographic problem—a birth rate of 1.61 children per woman—but the aging of the population was evident.

In turn, this demographic problem has put tremendous pressure on the pension funds in both countries. Without a labor force to infuse the fund with new money, the pensions are going to dry up long before a new generation of working Italians and French arrive to replenish the fund. My feeling is that both countries, but particularly Italy, will have to ease their labor restrictions, opening their borders to foreign labor in order to supplement this waning fund. They need the young workers from countries like Turkey and Ireland to ensure their pension funds do not fall apart.

Another long term problem involves all of the EC, not just France and Italy. I’ve said it before but I’ll say it again: I just don’t believe the the Euro can succeed. Sure, the Euro is a great thing. The world needs a Euro. But it’s just badly conceived. You simply can’t put eleven countries together unless they all have the same economic fundamentals. Of course, all the participants in the common market said they had the same fundamentals but everybody knows that many of the countries used phony numbers and massaged the books in order to appear fiscally prepared. Naturally, it’s difficult to see what these countries have covered up now that we’re in the midst of a bull market. But if and when there’s a downturn, I think you’ll see a lot of skeletons come out of the closet. And don’t forget: There are six new applicants from central Europe applying for entrance into the common market. These small economies are working overtime to make their economies to “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, there are industries that I believe will prosper no matter how quickly France and Italy can resolve there problems. 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 are in play that could make certain industries particularly lucrative in the future. Here are a few themes that I think could be very profitable in the future:

Banking. Just as the banking industry in the U.S. has consolidated, I believe the European banking industry is poised to undergo 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 all over the world is on the rise and this industry has already been in the process of consolidation all over Europe. With good reason, too. The U.S. defense industry has been consolidating for over a decade and the European governments and defense and aerospace industry players have just awakened to the fact that in order to compete with Americans, they need to join forces. This is a rare opportunity: How often does a government intervene to encourage an industry to consolidate? More often than not, the governments fight the creation of such industry behemoths in anti-trust suits. Here’s a situation where the government is actually encouraging it. 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 the interests or actions of any one particular country. In fact, I have heard many stories about countries that have actually paid for airplanes up front but never received their product 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 that many of these foreign countries are looking somewhere else 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 name products. In the face of a economic downturn, of course, these are often some of the first investments to suffer, but as the Asian and European economies continue to recover, these investments 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 prospect. I own a company called Cie des Alpes, a French company that owns a number of ski resorts around the country and that has huge real estate holdings that haven’t really been exploited yet. I believe as the demand for ski resorts continues (and the lines at the lifts continue to grow) this company is going to expand and exploit some of those choice opportunities.

Natural Resources. To tell you the truth, there aren’t that many natural resource plays in Europe. The few that do exist, though, have taken a beating over the past few years. I own Metaleurop, a metals company in France. While the stock has fallen over the past 2 years, I’m fairly optimistic about its opportunities in the 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 have also bought some ENI in Italy. With oil prices hovering around $25, I’m not sure I would tell anyone to buy either 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 U.S. major 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 just 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. It’s my feeling that 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, I still believe that are good places to invest in Italy and France. It’s important to remember that, unlike the U.S., the general 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 the levels of investment per capita ever reach anything near what we have in the U.S., Europeans could see a bull market for many years to come. It’s a potential opportunity of which we should all be aware.