Investors Shout Ol to New Budget Dance

After a 400-year slump, Iberia is back!

Not since the 16th century - when explorers for Spain and Portugal hauled back tons of spices, gold, and diamonds from their far-flung empires - has the peninsula enjoyed such a huge infusion of wealth.

Today, though, foreigners are hauling the booty to Iberia - and gladly.

Stock markets in Madrid and Lisbon have rocketed in recent months as investors have seized on some of Europe's most promising profit opportunities.

Leaner budgets

Propelling the surge is a new, straitlaced brand of economic policy, aimed at meeting targets for entry in Europe's monetary union.

"They recognized they had to get their economies in order, and they have done a terrific job," says Joan Gregory, manager of the Scudder Spain and Portugal Fund.

Through tax reform and austere budgets, Spain has chopped its budget deficit from 7.5 percent of gross domestic product (GDP) in 1993 to less than 3 percent today. Inflation has fallen to a 29-year low.

Portugal has also cracked the whip. The budget deficit last year was 2.4 percent of GDP, versus 4.9 percent in 1995. Inflation stands at about 2 percent.

Economic union will enable Iberian companies to trade and invest in Europe with less risk. They will also be able to leverage their lower costs into higher sales for goods and services elsewhere in Europe, analysts say.

Still, Iberia poses risks.

"The markets have run up a lot because of optimism over monetary union," says John Tribolet, a manager of Nicholas Applegate International Core Fund. "If that were to change, there would be some pretty sharp corrections."

And Europe's smaller countries might find the common interest rate either smothers growth or spurs inflation, analysts say.

Vulnerable to a US drop

But "the biggest vulnerability is a sell-off in the United States, because people will take a closer look at European markets, especially overvalued ones," says Brian Gendreau, emerging-market analyst at Salomon Smith Barney in New York.

Indeed, both Lisbon and Madrid are due for a correction, analysts say. "There is too much money chasing too few stocks," says Daniel Bennett of Finantia Brokers in New York.

"Valuations are somewhat stretched," says Richard Watt, manager of the Portugal Fund.