Despite Turbulence, France's Highflying CAC Might Still Have Wings

France's tech-heady benchmark hit a rough patch, but the declines may just be passing.
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The Parisian bourse

CAC-40

index was 1999's European markets pop star, bursting forth late in the year with so much verve and promise. It's a new year and a new reality, however, and the fickle tastes of investors have brought a stark selloff, driving many to question whether the tech and telecom-dominated CAC is more than a one-season wonder.

Tech, media and telecom stocks like pay-TV group

Canal Plus

,

Thomson Multimedia

(TMS)

,

Alcatel

(ALA)

and

France Telecom

(FTE)

, drove the 29% bull run of the last two months of 1999. Comprising nearly one-third of the CAC index, these stocks also led last week's 7% downturn.

"The French economy is firing on all cylinders," says David Potts, lead manager of

Investec Guinness Flight's New Europe Fund

, which has 17% of its portfolio in French securities. "Now the market's got ahead of itself. Long-term growth has not been undermined, but in the short run every man and his dog has invested in these stocks."

With the latest selloff, French stocks are not quite as stretched. But worries about overvaluation persist. As in the U.S., Y2K concerns, unfounded as they may have been, brought an expansion in liquidity levels. According to Potts, instead of putting these funds in cash, which would have been the market-prudent thing to do, investors dumped their nest eggs into the single basket of world tech stocks.

"Oh, it's a dangerous and volatile situation with a lot of money involved," says a trader with several positions in French stocks. "But it doesn't often matter if you're right at the wrong time. If you had pulled out a month ago because of overvaluations, you would not have gained as much as doing the 'wrong' thing."

Such excitement has many analysts cautioning that logic must return to the markets, that enthusiasm must tempered.

"For France, there is a high-risk spillover situation from the U.S., but that is something that people have been talking about for the past two years and it hasn't occurred," says Lloyd Barton, research economist at

PricewaterhouseCoopers

in London.

The same analysts who warn of overvaluations note that long-term growth prospects for many of the 40 listed companies on the narrowly traded CAC are good. A short-term selloff may be needed for a correction, but Potts and others believe that in the longer term a more grounded appreciation will occur.

Moreover, the economic news from France has been good -- surprisingly good -- with the unemployment level falling. Even after the December's devastating storms, GDP growth is expected to be between 3% and 4%, the strongest gain since 1989, driven in part by greater competitiveness of French exports due to a weaker euro. And analysts predict low inflation for France compared with its European brethren.

Yet to stem the overheating of smaller economies like Ireland, the

European Central Bank

is expected to raise interest rates slowly over the next year. Higher interest rates will bring down the less sexy, but heavily weighted financial sector. Banks and insurance companies represent nearly one-quarter of the CAC index, and their performance over the next six months may add drag to the CAC.

The bears may have to wait in the wings, however, since the other big story in the French markets -- continued consolidation of not only banks, but many industries -- could counter any drag that interest rates bring. Though it may not be as strong or striking as last year, the CAC may yet have the legs -- with an almost

Cher

-like determination -- to carry on.