Transcript Global Equity research

FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
Contents
2000 review
1
Equity Research - Contents
Global Equity research
 Two speeds - one world
 The technology crash
Economic Outlook


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2001 outlook
Long term scenario
USA
Europe
Japan
Regional valuation
Sector valuation
Investment Outlook



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Investment behavior
Investor strategy
Investment themes
Sector allocation
Copyright Forum Finance Group S.A.
Jan/Feb 2001
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
2000 review
two speeds one world
The new Paradigm?...
2000 marked a year that tested the New Paradigm. In a presidential election year where
the economy turned out to be stronger than many expected, where earnings beat most
estimates, inflation remained subdued, long term rates declined and mutual fund inflows
reached record levels, most investors expected the markets to move up. In fact, most major
investment banks predicted a positive year for both the broad market and technology.
A tale of two economies…
The nineties could be described as a decade of relatively strong economic growth, the
acceleration of 1998/99 however was due essentially to a boom in technology led capital
investment. The Internet boom, coupled with Y2K upgrade mania, caused investment in
new technology to skyrocket and the US economy benefited from increased productivity
and exponential growth in the “new economy”. For the “old economy” companies though,
it was for the most part, business as usual. Proof of the technology effect can be seen in the
top graph on page 4, showing the % contribution of technology CAPEX to GDP growth
(remember technology fixed investment represents only 7% of total GDP, yet at one pointJune 1999 - it accounted for 55% of GDP growth).
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While they enjoyed the upswing in consumer sentiment and the up move in the economic
cycle, these traditional industries did not experience growth anywhere near that of the
technology industries. Real earnings at the consumer level and corporate level had been in
decline since 1998 and the stock market, usually considered a leading indicator, showed
scant sign of growth in 1998, 1999 and early 2000. The S&P index, ex- technology, was
in fact up a mere 0.30% from 31.12.97 to 10.03.00 (the top of the technology sector).
2
The technology sector however enjoyed all of the leverage that a financial bubble could
provide. From excessively cheap capital to ever climbing equity markets, the growth in
earnings and sales looked almost too good to be true. Business in the early part of 2000
continued to roll in unabated, a left over of spending on Y2K, but as it disappeared so did
the good times. It started with e-commerce, moved into telecomm services and finished
with equipment companies. The market followed, with the most significant correction
ever seen in the technology sector, plunging the US economy into what may become a
prolonged period of economic indigestion.
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Jan/Feb 2001
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
Greenspan - Old Tools, New problem...
The US economic boom that had been in place for over 34 consecutive
quarters came to resemble two trains running on parallel tracks - one
old and one new - rather than the homogeneous economic growth we
had come to know. At the central bank level however, there was
concern that this growth could get out of hand, leading to a classic
boom and bust cycle.
Technology % of Non
Residential
Fixed Investment*
49%
Lacking the precision tools required, the fed set out to slow the
economy as it had in the past, by raising rates. Unfortunately the “new
economy” felt little impact from the rate hikes which started in mid
1999. With very little debt to speak of, most technology companies
had relied on capital markets and Venture Capital funding to finance
their working capital needs. The rate hikes and subsequent increase in
credit spreads and energy costs succeeded simply in slowing down the
“old economy” sectors, which were operating in a relatively slow
growth environment already.
47%
45%
43%
41%
39%
37%
35%
98
Q1 99
Q2
Q3
Q4
Q1 00
Q2
Greenspan’s only real weapons against the new economy were his
words. He tried to talk down the market and limit the “irrational
exuberance” as he termed it, which was creating a bubble in the
markets. As the technology sector accelerated its upward move, the
individual investor became more involved. Personal savings rates in
late 1999 and early 2000 turned negative as individuals saved less,
betting that market returns would boost their earnings and net worth.
Personal Income
10%
1991 to 2000*
8%
6%
4%
2%
0%
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Jul-91
3
Jul-93
Jul-95
Jul-97
Jul-99
Had the markets simply moved sideways from mid march, the
consumer and the economy would likely have escaped a serious
slowdown. However rather than predicting the slowdown, the Nasdaq
crash probably caused it. It impacted the already weakened consumer,
and caused the driving sector of the economy to come to a screeching
halt. The spill over of the negative wealth effect onto consumer
sentiment, and therefore demand for the output of industrial
production, was especially acute.
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Jan/Feb 2001
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
Markets - Old vs. New...
It was a year of significant sector rotation in the US, where in the first
three months Technology stocks boomed, while the “old economy”
sectors faltered badly. During the first technology correction (march to
may), these sectors picked up the slack, showing signs of breaking old
downtrend lines. It was however not to last as technology stocks made
a half hearted recovery and old line sectors under performed during the
technology recovery..
Technology CAPEX
% contribution to GDP Growth*
80%
60%
40%
55%
48%
36%
26%
18%
32%
40%
31%
26%
11%
29%
20%
-36%
0%
-20%
-40%
Mar-98 Sep-98 Mar-99 Sep-99 Mar-00 Sep-00
S&P 500 Performance*
1997
1998
In June the broader markets regained their predictive nature,
recognizing that the drop in the technology sector probably spelled
significant deceleration in growth. By mid year defensive stocks had
begun to outperform and would in fact do so for most of the remaining
months, along with a revival in the financial sector as the probability of
rate cuts came into view.
1999
2000
2000
to March full year
80%
60%
40%
20%
0%
The year ended with the S&P ex-technology outperforming the
technology sector for the first time since 1997 (see chart below). The
Nasdaq lost 40% of its value (56% from its highs). In retrospect it is
clear that the market was confirming the fears we had at the beginning
of the year and discussed again in our mid year review. The economy
was being pushed towards a recession, yet no-one was ready to admit
it.
Valuations plummeted and analysts continued to call for a buy on the
dips, although evidence of a mounting slowdown became more clear,
with leading indicators turning negative, manufacturing showing signs
of stress and inventory levels on the rise. Technology companies lost
part of their markets in the e-commerce meltdown and in a
rationalization/consolidation of the Telecommunications services
business. To add to matters, the stock market correction had depleted
the spending power of the American consumer.
-20%
-40%
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S&P Technology S&P ex-technology
4
In short it was a very difficult year for the investors. The stage was set
for a promising 2000, but it became a year of violent sector rotation,
short unpredictable trends. Volatility was the watchword and it
impacted not just technology but also blue chip household names such
as Proctor and Gamble, Kodak and Xerox - all of which saw one day
losses exceeding 20%. Europe in General outperformed the US and
the sectors to own in 2000 were utilities, pharma, food and financials.
*Bloomberg Data, Federal Bureau of Economic Analysis
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Jan/Feb 2001
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
5
Equity Research - Technology Review
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Technology -the crash
The year 2000 was a year of exceptional volatility. It saw the technology laden
NASDAQ rocket to all time highs early in the year, causing many legendary
value hedge fund managers to finally close up shop. Ironically their departure
marked the beginning of what became the steepest one year decline ever
experienced on the NASDAQ and a return to value fundamentals.
The technology move was based upon a number of factors including the
popularisation of the internet, a revolution in communications (wireless and
optical), the Y2K effect and a final but enormous inflow of Venture Capital funds
into the sector.
The Internet and communications revolution saw the creation of an ever growing
number of technology companies, funded with easy money in times of eager
venture capital, accommodating equity markets and low interest rates at the
beginning of the cycle. None had profitable business models and their space was
becoming more competitive as each second passed. To remain competitive and
meet what seemed like never ending demand growth these companies spent ever
increasing amount of their new found wealth on expanding their networks,
upgrading their equipment and acquiring smaller competitors at a dizzying rate.
The retooling across all businesses that took place in preparation for Y2K added
to the expansive business environment in which all tech companies participated.
Capital spending in 1999 and 2000 on technology skyrocketed and many thought
that the cyclicality of the business had passed; a secular technology boom had
begun and the massive run up in technology valuations seemed remarkably
justified.
Adding fuel to the fire, investors threw ever more money at any idea, profitable
or otherwise in hopes of turning a quick and substantial profit. The boom had
turned ordinary housewives and car salesmen into wall street wizards and at
home venture capitalists. Everyone or so it seemed, was in on the party and soon
talk of valuation was met with disdain. The ever increasing number of venture
capitalists with money to spend, simply wanted in. By the end of 2000 over
$83bln had been poured into new ventures, a 40% increase over 1999 which
itself totaled more than the five previous years combined!
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Jan/Feb 2001
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
The confluence of these events conspired to set up the inevitable fall
of the technology sector. One by one the leg on the table of the new
paradigm became shaky.
Annual Fiber Optic Equipment Sales Growth*
45.00%
40.00%
35.00%
It started with the internet e-commerce sector. Tired of the endless
“profitless” business models, investors, both private and public,
began to turn away resulting in the downfall of many cash needy web
companies. This caused the established brick and mortar companies
to re-examine their blind rush to “webify” their offerings. Their web
strategies would be put on hold, as seemingly ferocious VC
subsidized dot.com competition appeared on the wane.
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
1997 1998 1999 2000
2001
2002 2003
2004
Digital Mobile Comms equipment sales*
140%
120%
100%
80%
60%
40%
20%
0%
1998
1999
2000
2001
2002
2003
2004
Communication Equipment Growth Rates*
25
Network Equipment
20
Eager to compete in the limitless world of communications,
companies new and old, offered unreliable technology at rock bottom
prices, on nothing but borrowed working capital. The rush to
provide a broadband alternative, from both cable and telecom
companies resulted in the clash of two competing technologies, DSL
and Cable modems; neither of which offered a feasible solution to
the client nor for the service provider. As demand slowly waned, first
from the cash starved e-commerce companies and then disgruntled
consumers, the downward spiral began. To stop the bleeding, these
companies cut marketing and equipment budgets, starting trouble
upstream at the service and equipment vendors.
Voice/Data Enterprise Equipment
15
The capital markets all but shut down to new ideas, sub investment
grade financing rates skyrocketed, and many companies, operating
on an already thin line, were forced to throw in the towel. The raft of
new companies spending money on ever improving technology were
now removed from the equation and equipment manufacturers faced
a significant challenge to maintain growth.
10
5
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0
6
Global Telecom Equipment Sales
Growth*
16.00%
Finally, as the markets fell apart, the economy began to slow
significantly. A leading indicator or a self fulfilling prophecy, the
impact of market losses on consumer behavior was significant. As
capital investment slowed, the consumer sector did nothing to pick
up the slack. Technology powerhouse states such as California saw
the ominous warning on the wall, technology brought them a boom,
but it would also bring them the bust. The economic downturn
would be the final leg to fall, making the reversal of fortunes in the
new “New Economy” complete.
12.00%
8.00%
4.00%
0.00%
1999 2000 2001 2002 2003 2004
*Telecommunications Industry Association, 2000 review
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Jan/Feb 2001
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
Economic Outlook
2001
Economic Growth - lowering expectations...
The split between the new and old economy made it difficult for the
Fed to engineer a soft landing. Its intervention tools impacted
traditional industry much more than they did the new economy and
the financial bubble it had created. While rising rates helped to slow
an already lethargic mainstream economy, it was the severe
correction in the technology bubble that truly pushed the economy
over the edge.
Residential Fixed
Investment
% Change annual*
The deceleration of technology investment resulted in the crash of the
Nasdaq which created a negative wealth effect and sentiment impact
on consumers. As consumer spending represents 60% of GDP, the
loss of confidence at the consumer level created a dire situation for
the economy.
Non-Res. Fixed
Investment
% Change annual*
The significant reduction in capital investment (most notably in the
technology sector), and a dampened consumer sector - the two main
growth drivers of the last nine years of economic growth - make near
term prospects dim.
Consumer weakness...
Real Earnings continue to fall and the savings rate has finally turned
negative (due to the reduction in equity gains). While in the past,
stock market gains and real estate appreciation have acted to offset
this gap, this is no longer the case. Combined with a significant
increase in layoff announcements in the US as well as the continued
decline in real earnings, the case for immediate consumption led
relief is weak.
Real Earning
4%
12 month % Change*
3%
2%
1%
0%
-1%
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-2%
7
And a Capex Meltdown...
1050
New House Starts*
Moreover, as the economy weakens and the telecommunications and
technology sectors continue to experience soft demand, it is unlikely
that the negative trend in capital investment can be immediately
reversed. In fact even industry data points to a slowing in investment
growth across a range of technology industries from PC to fiber
optics growth.
950
850
750
650
550
450
350
Jan-90
Jan-92
Jan-94
Jan-96
Jan-98
Jan-00
*Bloomberg Data, Federal Bureau of Economic Analysis
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Jan/Feb 2001
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
The spending boom induced by the Y2K scare and the zero cost of
capital (see pages 5 & 6) has lost much of its momentum, networks have
been upgraded and the telecommunications industry is in the middle of
severe consolidation - at least two legs of the growth foundation are
missing.
The vicious circle has also impacted corporate profits, which in turn
further reduce companies’ ability to reinvest. 2001 looks to be a year of
significant earnings slowing and a digestion of over-investment across
the entire technology landscape.
But some relief in sight...
Personal Savings Rate ( US %)*
The news however is not all bad. As we outlined in our last report, we
believe that a fundamental change in the economic cycle has taken
place, shortening the cycle through a combination of supply chain
management and increased productivity.
Taken together, the impact on the cycle has been significant. The cycle
has become shorter and less severe than in the past decades making
recessions shorter and more manageable (see mid year 2000 report).
Corporate Profits ( US % Change)*
In our outlook for 2001 we feel that the economic slowdown will likely
be deeper and slightly longer than the market expects, due to the impact
of the severe correction on technology investment and consumer
sentiment. We do however believe that aggressive Federal monetary
policy and accommodative fiscal policy at the political level could be
enough to stem the tide of negative economic momentum.
With this in mind we have adjusted our economic cycle to reflect a
deeper decline in US GDP growth in the first half of 2001. It is likely
that this slowdown will consist of 5 quarters of below 3% growth
including at least one quarter of negative growth.
US Inventories to Sales Ratio
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1991 to 2000*
8
Industrial Production YoY change %*
Growth should start to re-accelerate by the fourth quarter of 2001, as the
new economy digests the excesses of the investment cycle of
1998/1999. The aggressive move by the Fed and announced tax cuts
however should allow the old economy to significantly improve its
prospects. Major improvements in supply chain and production
management tools over the past decade will allow for a rapid work
through of excess inventory and adjust quickly to reduced growth
expectations.
9%
7%
5%
3%
1%
-1%
-3%
-5%
*Bloomberg Data, Federal Bureau of Economic Analysis
European growth, which has already shown some signs of weakening
will likely see its lows near the end of 2001/ 1st quarter 2002. While a
de-coupling of sorts has taken place, we feel that a US slowdown will
take the rest of the world with it, although to a lesser degree than in past
years.
Copyright Forum Finance Group S.A.
Jan/Feb 2001
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
Our long term scenario






The Fed succeeds in prompting a recovery through very aggressive
expansionary monetary policy, and the economy rebounds in late 2001/early
2002.
The New Economy stabilizes at growth levels more inline with the long term
average.
European economies, less dependent upon new economy industries, lag US
trends by one to two quarters and therefore a slowdown in Europe developing
in the mid 2001 will be likely followed by an upturn into late 2002.
The Japanese economy continues its slow climb out of recession, peaking in
mid 2002 along with the peak in the US economic cycle.
US growth will bottom at -1.0% in Q2 and peak in 2002 but at a much lower
rates than 1999.
Secular global growth will trend down to historic levels.
The Economic Cycle
USA
Europe
9%
Japan
6%
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3%
9
0%
Dec 99
Dec 00
Dec 01
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Dec 02
Jan/Feb 2001
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
USA
The Economy
2000 Stock Index
Performance*
DOW JONES
-6.19%
S&P 500
-10.16%
NASDAQ
-39.6%
*in local currency, to Dec. 31, 2000
14%
Money Supply (US)*
12%
10%
8%
6%
4%
2%
Falling interest rates will provide significant benefits to second
tier company profitability revitalizing business investment over
the fourth quarter.
Declining interest rates spur the housing market before year end
and cause consumer demand to pick up slightly.
Inflation risk minimized as energy prices decline along with the
growth rates in the global economy.
Steeper yield curve and falling corporate spread indicate higher
growth expectations.
Oil prices have peaked and may go lower than many expect.
Sharp decline in CAPEX and Consumer spending will limit
growth in the first 3 quarters of 2001.
Economic slowdown deeper and longer (by 1 quarter ) than the
market expects.
The long term outlook is for more moderate growth as
technology spending settles to more historic levels.
Loss of huge flow of zero cost capital (venture capital, internet
equity bubble) slows technology spending in the near term and
causes productivity growth to plateau.
0%
The Market
-2%
-4%
Real interest rates (US)*
12%
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8%
1
4%
0%
-4%
Earnings outlook weak, but comparisons become favorable as
we move into the second half of 2001.
Outside of technology market valuations appear extremely
attractive,
Expect aggressive FED policy to spur an economic revival and
render some valuations more reasonable in regard to valuations
models.
Technology, cyclical consumer, industrial and financial
sectors should out perform in the first quarter due to declining
Fed rates and expectation of a quick end to the slowdown.
Strong market move in Q1 may make march/April attractive
periods to reduce exposure as evidence mounts of continued
economic weakness.
Technology valuations still imply relatively high levels of
growth - which may only be present in certain sectors.
*Bloomberg Data, Federal Bureau of Economic Analysis
Copyright Forum Finance Group S.A.
Jan/Feb 2001
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
Europe
The Economy
2000 Stock Index
Performance*
CAC 40
-0.54%
SMI
7.46%
DAX
-7.53%
FTSE
-10.12%
*in Euro to Dec.31, 2000
280
CRB Index*
260
240
200
180
160
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The Market
 End to rate hikes make bonds more attractive than short
term paper. Rates have likely peaked, making longer
term bonds more favorable.
 With the Euro’s late 2000 rise and early signs of wage
increases, earnings outlook begins deteriorates in early
2001.
 Earnings comparisons in 2001 are very difficult, causing
year over year growth to slow.
 Valuations remain high in certain markets and while a
correction appears more likely markets may simply trade
sideways most of the year.
220
1
 Energy price declines and strengthened Euro remove
pressure on consumer prices, allowing the central banks
the space to ease rates in Q2/Q3 2001.
 Euro remains stable to strong in the 1st quarter of 2001,
while a combination of economic slowdown in Europe
and renewed strength in US economic growth make the
outlook past Q1 less certain. Potential for stability at
lower levels or resumption of declines in Euro.
 Business investment remains high, while investment in
IT continues to top the list.
 Unemployment continues its downward pace, giving end
demand in Europe some support.
 Slowing rates of growth continue until early 2002, as US
rebound spurs global growth.
 Growth rates exceed those of the US throughout most of
2001.
 Slowdown in US economy, combined with rise in Euro of
late 2000, should work to slow progression in EU growth
*Bloomberg Data, Federal Bureau of Economic Analysis
Copyright Forum Finance Group S.A.
Jan/Feb 2001
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
Japan
 The Economy
2000 Stock Index
Performance*
Nikkei
-27.92%
Topix
-25.46%
*in Yen to Dec. 31, 2000
 Corporate earnings continue to rise, as economy
maintains very slow climb out of recession.
 Corporate Investment remains the main driver of the
economic recovery.
 Unemployment has bottomed, setting the stage for a
consumer recovery beginning near the middle of
2001.
 Consumer spending continues to lag investment
spending through out the year.
 Key concern is the state of Japanese government
budget and its ability to pay for programs initiated to
spur demand.
 US Slowdown impacts Export company sales growth.
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 The Market
1
 Corporate restructuring no longer the watchword,
earnings, growth and management become key in
stock selection
 Market valuation has entered more reasonable levels,
as earnings begin to rise.
 With interest rates on the rise, some Japanese
investors (traditionally very conservative) may
choose to remain in interest bearing accounts thus
giving less impetus to domestic equity investment.
 Heavy IPO schedule and low volumes (lack of
domestic investors) will keep the Nikkei in a trading
range for the foreseeable future.
Copyright Forum Finance Group S.A.
Jan/Feb 2001
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
Regional Valuation
EU earnings growth will slow into 2001…
Regional valuations
Changes (from june’00)
PE
EPS
Growth
The rising Euro, high energy costs and a cyclical slowing in the US
work to decrease earnings growth in Europe in 2001. Moreover, the
acceleration of economic growth in Europe in 1999 and 2000 brought
an acceleration in earnings growth making comparisons more
difficult for 2001.
Old New Old New
Making European stocks expensive...
Europe
22 21 13% 6%
France
Germany
UK
Switz.
Sweden
Italy
Holland
30
18
22
19
21
18
16
23
18
21
19
18
23
15
14
19
10
11
13
13
12
6
8
7
5
3
5
5
France, Italy and the Scandinavian markets all appear to be the most
at risk of correction into 2001, as they will experience the most
pronounced growth reductions and remain relatively expensive.
Japan
55 48
16
10
USA
25 23 12
6
The specter of slowing US growth is now upon us and while 2000
was until the fourth quarter a banner year for earnings growth, it has
made for some tough comparisons. We expect that earnings revisions
going forward will continue to be on the downside, and that not until
mid year as the economy begins to show meager signs of recovery,
will analysts start to upgrade their earnings outlook.
Est. from Morgan Stanley Dean Witter research
And the US follows its lead…
But Valuation has leveled off...
Global Equity research
But outside of the technology sectors, valuations have come down to
relatively reasonable levels. We believe that the US market is trading
near fair value levels, and that any broad market sell off would be
short lived.
1
While Japanese consumption appears to have bottomed….
The most recent Tankan survey, as well as various leading indicators
appear to indicate that unemployment has leveled off, and that
consumer confidence is beginning to rise. While most retailers have
not yet felt the effects, we believe that the bottom in the consumer
market (as we outlined in January) is now being reached.
Copyright Forum Finance Group S.A.
Jan/Feb 2001
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
And Earnings are set to resume normalized growth
patterns….
Japanese companies after a nine year slump, have realized
significant operating earnings growth in 2000 and we now
expect that normalized earnings growth can be expected.
Growth Expectations
‘01
%
‘00
%
Technology
Basic Mat.
Capital Goods
Telecom Svc.
Cons. Cyclical
Cons. Staple
Energy
Financials
Healthcare
Transportation
Utilities
6.6
6.6
14.4
-4.8
-1.0
11.7
-4.8
12.9
13.9
22.7
11.4
30.7
15.9
13.1
-2.3
-6.8
8.1
118
10.1
16.0
-0.8
20.1
S&P
7.8
17.2
*I/B/E/; S&P; Prubache Estimates
PEG by Sector
Global Equity research
Jan. Mar.
‘01
‘00
1
Technology
Basic Mat.
Capital Goods
Telecom Svc.
Cons. Cyclical
Cons. Staple
Energy
Financials
Healthcare
Transportation
Utilities
1.5
1.4
1.3
1.4
1.3
1.8
1.2
1.3
1.6
1.5
1.6
2.5
1.3
1.2
1.7
1.3
1.7
1.4
1.2
1.5
1.1
1.9
S&P
1.5
1.9
Sector Valuation
Where are the profits?
As evidenced from the charts on the left, both the technology
and telecom services have seen their valuations decline
significantly. PEG ratios in technology, an important valuation
metric, have dropped to historically low levels and in many
cases below the market multiple. On a sector by sector basis
some are trading well below 1x growth, a valuation which
represent significant value.
In terms of earnings growth, most sectors and the market are
seeing downward revisions to earnings estimates, due of course
to the looming recession and technology meltdown. Integrated
energy companies appear to have seen their earnings peak and
experienced the most severe downward revisions followed by
technology and basic materials.
There appears to be a case for investment in financials and basic
materials and consumer cyclicals based upon earnings growth
and PEG valuations. While the transport sector looks to be the
most promising in terms of earnings growth revisions. Should
our cyclical recovery take place, these sectors appear to be very
well placed to benefit. Telecom services and technology appear
to have the most bad news built into their valuations, making
them attractive on a contrarian and long term growth basis.
*I/B/E/; S&P; Prubache Estimates
Copyright Forum Finance Group S.A.
Jan/Feb 2001
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
Investment Outlook
Investor Behavior
Under certain circumstances investors will be willing to look over the
valley and disregard a forthcoming slowdown.
The degree to which they will anticipate and discount the future
depends upon a number of factors
 Anticipated length of the cycle
 Anticipated depth of the cycle
 Valuation (investors will place a floor on prices)
 Investor confidence in consensus numbers.
The market tends to react ahead of the economic indicators. The lag
between business fundamentals improvement and market movement
can be anywhere from 3 to 9 months
As shown in the table (pg.8) outlining the business cycle peaks and
troughs, the average deceleration period is 11 months (having been as
short as 6mths - 1980).
We believe that this slowdown will be longer than expected, lasting
between 9 and 12 months and will show signs of outright contraction.
Investors will be attracted to valuations in various sectors and
supported by the relative moderation of this cycle will remain positive
on the investment outlook as a whole.
Relative Market performance and a classic business cycle
Global Equity research
Consumer
Discretionary
1
Consumer
Durables
Select
Technology
Capital
Goods
Energy
Chemicals
Financials
Consumer
Staples
Pharma
Copyright Forum Finance Group S.A.
Jan/Feb 2001
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
Investment Strategy
(Recessionary Phase) Slowing US economy into 2001:
 Short term rates (US) have peaked and even started going down.
 Fundamental business impact across the board is negative.
 Cyclical- Fixed cost industries suffer most in this period i.e.. Consumer
Durable, Housing, Capital goods. Due to lingering impact of high cost of
capital and the invariability of their cost base.
The Business Cycle
While the study of the
business cycle aids in the
development
of
an
investment outlook, caution
is required. Rarely does a
cycle repeat itself exactly,
and its impact on broad
sectors is difficult to
pinpoint.
This study
therefore acts as general
guidelines
for
such
analysis.
(Trough) Bottoming out of slowdown in Mid/late 2001:
 As trough is reached, consumers feel more comfortable in their economic
future and begin to make more discretionary purchases. When interest rates
bottom businesses see opportunity to begin expansion anew.
 Fundamental business impact is positive for Consumer discretionary
(retailers) and certain Financials (Lending banks).
Re-acceleration of growth in late 2001:
 As the economy begins to re-accelerate, firms that reduced inventories
during recessions must increase production, resulting in an improved outlook
for both employees and business.
 Consumers, spurred by low interest rates and increased confidence, begin to
consider purchase of larger ticket items.
 Fundamental business impact positive for Consumer durables, industrials and
capital goods
Confirmed growth pattern 2001/2002
 Having reached maximum capacity companies are obliged to increase
capital expenditure to meet new increased demand.
 Increased economic activity begins to have impact on demand for
commodity goods and deep cyclical products.
 Fundamental business impact is positive for chemicals (late stage cyclicals)
and energy.
Global Equity research
Relative fundamental performance and a classic business cycle
1
Consumer
Staples
Consumer
Discretionary
Telecom
Services
Software
Semiconductors
PC’s
Select
Financials
Consumer
Durables
Energy
Select
Financials
Chemicals
Capital
Goods
Copyright Forum Finance Group S.A.
Pharma
Jan/Feb 2001
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
Investment Themes
Interest rate Cycle:
Growth &
Technology
At FFG our investment
focus is based on
growth. We search out
those stocks and sectors
that
will
maintain
sufficient growth over
the long term to
outperform the market.
This philosophy has
lead us to focus upon a
number of sectors most
notably of which is
technology.
Slowing EU growth and falling US rates favour Large Cap,
Global financial names (Citibank, Zurich Insurance). As the
economy progressively picks up speed in late 2001, a move
into regional consumer banks would be likely.
We think that select US industrials now look attractive, as
valuations have bottomed, rates are falling and investors look
over the valley (GE, 3M) .
Weakened Asian economies, slowing EU growth and lower
energy prices support reducing exposure to oil stocks.
Continued restructuring and focus of companies on core
business support further gains in business services/outsourcing
companies (Flextronics, Adecco).
US Recovery:
At this stage of the cycle, economic recovery favours slightly
cyclical consumer companies such as Home Depot, Wal-Mart,
Federated Department Stores, Costco.
Mixed bag of growth places focus on regional differences.
 In Europe defensive consumer and industrials should
outperform.
 In the US we focus on consumer discretionary and interest
rate sensitive.
 Lack of consumer follow through in Japan makes
consumer area unattractive.
Global Equity research
Technology, & Life Sciences Growth:
1
Fed easing and Tax cuts make cyclical recovery more likely
Capital Investment continues to favour IT spending.
However build out in communications industry slowing.
Internet revolution continue to dominate trends.
Focus on interest rate sensitive Telecom services,
Semiconductors and PC producers as well as value added
software and optical technology. (Worldcom, Vodaphone,
Apple, JDS Uniphase, Applied Materials)
Aging population and medical technology advances spur life
sciences growth. Pharma group provides less out-performance
potential after strong move in 2000 ( Pfizer, Ares Serono,
Aventis, Amgen).
Copyright Forum Finance Group S.A.
Jan/Feb 2001
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
Sector Allocation
Technology 35%
Why Technology:
•Competitive pressures
•Capital investment acceleration
•Solid long term EPS Growth
•Reasonable valuation
•Favorable timing
Focus on:
•Value technology
•Interest rate sensitive
•Semiconductors, PC makers, Telecom services
•Software
•Internet infrastructure
•Broadband communications
•Risks:
•Wireless equipment - could see short term weakness in sector before
3rd generation build out begins.
•Economic downturn more severe than expected
•Telecom services meltdown has farther reaching impact on
infrastructure build out than expected.
Life Sciences 10%
Why Life Sciences:
•Earnings to outperform broader market
•Aging population
•Technology enhanced productivity
•Consolidation potential
•Genome advances creating new product cycle in biotech
Global Equity research
Focus on:
1
•Biotech
•Mid sized take over targets
•Accelerating EPS with limited patent Expiry
•Avoid Pharma
•Risks:
•High Valuations
•Late in Cycle
•Generic drug competition
Copyright Forum Finance Group S.A.
Jan/Feb 2001
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
Financials 20%
Why Financials:
•Interest rate cuts in the US - favorable timing
•Sector Consolidation
•Recovery of insurance sector
•Economic recovery in late 2001
Focus on:
•Asset Management
•Global reach
•Brokers and European take over candidates
•Insurance (Glass Steagal)
•Risks:
•Economic downturn more severe than expected - credit risk
•Financial market weakness may hurt investment gains
•Lending volumes may peak with economic growth
•Trading income slows with equity markets
Consumer 20%
Why Consumer:
•Defensive US names should no longer be favoured
•European defensive should become moderately overweight
•Positive correlation to rising incomes
•Interest rate cuts favour more cyclical consumer names such
as discount department stores, DIY.
•Historically low valuation
Global Equity research
Focus on:
1
•European defensives
•US slightly discretionary companies
•Global Brands & Global Reach in distribution
•Avoid durable and luxury goods for a few more months.
•Risks:
•US recovery slows
•European slowdown arrive more quickly than expected
Copyright Forum Finance Group S.A.
Jan/Feb 2001
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2001
Industrial/Energy 15%
Why Cyclicals:
•Investors will look over the short slowdown in US
•Interest rate driven market recovery
•Oil price moderation
•Increased oil E&P activity (benefits services, engineering
& construction firms)
Focus on:
•Infrastructure
•Business Services
•Energy - reduced to 5% in late 2000
•Basic Materials
•Value Added Chemicals
•Risks:
Global Equity research
•Valley is longer than expected
•Emerging market slowdown
•Oil price weakness negative for Energy sector.
2
Copyright Forum Finance Group S.A.
Jan/Feb 2001