FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
Contents
1
Equity Research - Contents
Global Equity research
 2000 Outlook
 Overview
 1999 A Brief Review
 A New World
or is inflation around the
corner?
 Economic Outlook
 USA
 Europe
 Japan
 Emerging Markets
 Investment Outlook
 Key Themes
 Valuation
 Disruptive Technology
 Sector Analysis
Advisor to ZT- Zurich Trust
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
2000 Outlook
Overview
• Key Themes:
 We have a positive outlook for the global economy in 2000 and
expect worldwide growth to recover to above the long term trend in
the 4 to 4.5 % range.
 We expect a global round of central bank tightening as fears of
inflation mount during the first half of the year and the ECB looks to
establish its credibility.
 Synchronized global growth will cause an acceleration in inflation,
however a myriad of factors will combine to offset inflation
pressures to keep the increases modest.
 Stock market performance should track earnings growth overall and
while breadth will expand slightly to reflect the improved economic
reality, it will remain weak and stock selection will be of the utmost
importance.
 We expect a continuation of 1999 trends with a renewed battle
between growth and cyclical stocks.
Given the expected
performance of the global economy, deeper cyclical and global
industrial stocks should outperform but technology sectors should reestablish their dominance by year end.
Global Equity research
 Volatility will continue to run high in 2000, and we expect a
correction to take place in the early part of the year especially in the
high P/E sectors as inflation fears emerge.
2
 The continued strong performance of the US economy and perceived
high returns of US stocks will offset the growing trade deficit to limit
US dollar weakness for at least one more year, in our view.
 The Euro will likely finish slightly higher than today as European
growth picks up, while the Yen will weaken marginally as the
Japanese government works hard to maintain levels conducive to
continued economic expansion.
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
1999 A Brief Review
1999 was an exceptional year in the high-tech sector, benefiting FFG
clients in both technology and global balanced accounts. The time has
however come to re-assess our positions and build the base of
investment themes for the up-coming year.
1999 in review:
The year began on the heels of a fantastic market recovery following
the LTCM/Russian debt induced crisis of October 1998. From the
Dow industrial index to the technology laden NASDAQ US markets
posted 30 to 60% gains in the twelve weeks following the early
October lows. In Europe the recovery while present, was slightly less
convincing as the European markets were hit harder on the downside
and did not recover as quickly as their American counterparts.
Global Equity research
This development surprised many, as the valuation of European
markets was more reasonable than that of the US and a new
confidence in EU earnings growth was developing. As it happened,
the balance sheet risk of many European financial institutions were
heavily exposed to emerging markets, and the enormous liquidity
pushing the US markets on the upswing was absent from any
European equity recovery. Their under-performance also came partly
from the composition of the indices. Where the US market is heavily
skewed towards growth and technology companies, most European
indices have a more traditional “old economy” make up.
3
The year started off with a continued up move in early January to
valuations that many judged untenable. As a result, almost all of the
developed markets treaded water and did not see their January highs
again until late March, driven by the outlook for growth. The Global
economy was still on the mend, but was far from the ailing patient it
was just six months before. By the end of the first quarter, consensus
that growth would accelerate pushed cyclical stocks to new highs over
a short three week period.
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
A weak summer rally developed following the cyclical move, to bring
stocks to new highs by mid summer. With the traditional summer rally
under its belt, the market proceeded to fall off its highs well into
September. All of the developed markets from Tokyo to Frankfurt
displayed the same tendency, and as the turn of the century approached
many wondered about the implications of the Y2K phenomenon.
Autumn brought both changing colours and a feeling that the world
was more or less ready for Y2k. This renewed confidence unleashed a
flood of money onto the markets, especially in the technology sector
which rocketed up over 50% from October to the end of the year.
Throughout all of this, the market continued to provide little comfort to
the majority of fund managers. Market breadth remained extremely
poor all year. Performance was based upon the moves of a few stocks,
over short periods of market movement. The world’s central banks,
fearful of the inflation that rocketing oil prices and economic strength
began to take back the rate cuts they made in the face of the Asian
crisis in 1998. Valuations remained extremely high and the new “Dot
Com” world confounded all but a few analysts. Those managers who
had embraced the calls for value and the notion that rates would soon
retreat to their low levels of 1998 paid a heavy price.
Global Equity research
When all was said and done, Technology was once again the big
winner for the year, as were some basic materials sectors (aluminum)
and global industrial stocks. The European markets performed well,
but dollar strength pushed the US returns ahead for the year. Interest
rates moved higher, making it one of then first years on record where
the average bond fund lost money for investors. And the equity
market’s volatility continued; 80% of trading sessions saw the S&P 500
move 1% or more.
4
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
A New World
or is inflation around the
corner?
1999 was a year in which most believed that the multiyear bull
market had probably run its course. The feeling was that while the
market may post marginal gains, it would prove to be a difficult year.
Productivity gains would slow, and while few predicted a recession,
most were waiting for a slowdown that never materialized. The
overwhelming view was for inflation to fall and for interest rates to
continue their downward spiral.
Today, the majority are looking for moderate global growth and a
potential slowdown in the US. Few however are on the lookout for
wage pressures in the US and Europe, a slowing rate of productivity
growth or inflation.
A greater inflation risk than ever before...
We believe that growth in 2000 will exceed expectations and that the
risk to the inflation outlook is to the upside. At this time last year,
we felt that an inevitable rise in prices was about to filter into the
economy and that the risk on rates was more to the upside. As it
turned out, oil prices shot up and interest rates broke the long down
trend that had been in place.
This year we again feel that the consensus for no inflation is wrong.
Even more so than before, this year brings with it a synchronization
of global growth long missing from the equation. We firmly believe
that this year will prove to be the test of the “new economic
paradigm”.
Global Equity research
Probably offset by a number of factors…
5
While we think that the risks to the consensus view is that inflation
rears its ugly head, we believe that the world today has a number
tools with which to keep price increases mitigated. Our view is that
inflation returns to trend line growth (above consensus), but that this
growth is tenable given the changed face of today’s global economy.
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
Technology and the Internet are a big deal…
While we are not new paradigmers, for whom a new world order is
permanently in place, we are of the opinion that the internet and the
technological advances that go with it represent a disruption to the
“old way” of doing business. These “disruptive technologies” are
changing the way companies compete and are having a significant
impact on the pecking order within industries that will have a lasting
effect on the economy.
Combined with global access to human capital…
Japan Capacity Utilization Rate
The globalization of the world’s economies, combined with
increased technological prowess has made it possible for companies
to source employees outside of their domestic market. This excess
capacity in the global market has therefore alleviated a certain degree
of pressure on the available domestic labor pool.
Increasing productivity and Reducing the impact on wages…
The B2B and B2C methods of distribution and acquisition are
reducing costs, increasing productivity and adding new leverage to
old business models. The effects have already been witnessed in the
US. At a time when labor markets have never been tighter, wage
inflation is non-existent with unit labor costs up 3.1% in 1999 just
above the cycle lows of 2.7%.
US Capacity Utilization Rate
While real wages are increasing, most of the rise has been offset by
increased productivity (non-farm unit labor cost rise of 4.6% with
productivity increases of 3.6% - translating to a real cost increase of
only 1.5%).
Global Equity research
Creating a virtuous circle of technology investments…
6
While this process will eventually run its course, it is clear that the
advances being made today in the US are at an early stage. In
addition this same phenomenon will be felt in Europe and eventually
Japan before all is said and done. Management realizes that their
next challenge will be to gain competitive advantage through
technology investment. The increased spending in technology will
maintain the inflation free growth we have witnessed to date.
With capacity Utilization on a global basis at low levels…
In addition to wage pressures, the potential during a synchronized
global expansion for the output gap to decrease to unsustainable
levels worries some.
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
The current situation however shows that capacity utilization levels are
at relatively low levels. The US has not seen such levels since the mid
80;s and Japan is currently operating at a 30 year low while
restructuring in Europe has left large amounts of capacity available.
And commodity prices well off their highs…
Commodity Price Index
While commodity prices have risen with the price of oil this year, they
are still significantly off of their pre-Asian crisis levels, while gold has
resumed its downtrend. Oil prices have more than doubled since the
end of 1998 and are hovering at their highest levels since 1995 (ex-gulf
war spike). While some continued upside pressure does exist
(stemming mostly from OPEC political risk) the most likely direction
of oil prices appears to be down side, as Venezuela faces a domestic
crisis and current heating oil demand will pass as the unseasonably
cold weather subsides. And while we think oil prices will not move
higher, we do believe that global recovery will be enough to sustain
prices at a reasonable price. Such an outlook however precludes the
type of price increases (and thus commodity/input price inflation)
which we saw in 1999.
And interest rates have already returned to their pre-Asian crisis
levels…
US Long Bond Rate
With interest rates already relatively high any upward bias will be
carefully implemented. While the ECB will be quick to establish their
credibility, they will do so with an eye to not breaking the momentum
in the European economic recovery. The federal reserve can be
expected to continue its upward bias to rates at least until mid year
given that consumer and business confidence (in the US and Europe)
are running near all time highs and look set to continue.
Combined will likely work to keep inflation at manageable levels
for at least another year…
Global Equity research
Our belief then is that a combination of the following factors:
7
Technological Innovation
Globalized Human Resources
Productivity Increases
Low Capacity Utilization
Slowing Commodity price gains
Rising Interest rates
will work to minimize the risk in the near term. Longer term however,
as the gains from productivity and technological innovation begin to
plateau, the situation may get more serious. For this reason we remain
vigilant in our outlook for inflation, while cognizant of the effects of
the current technological revolution..
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
Economic Outlook
USA
• Key Themes:
1999 Stock Index
Performance*
DOW JONES
25.21%
S&P 500
19.53%
NASDAQ
85.59%
*in local currency
Global Equity research
NASDAQ Vs. S &P 500 - 1999
8
 US economic expansion continues strongly,
however rate increases and the Y2k inventory
build may contribute to slight slowdown early in
the year.
 Technology based productivity keeps inflation
rates at bay, although the upward pressure on
prices accelerates.
 Commodity prices rise slightly, while oil prices
touch highs early in the year, before stabilizing
at lower levels
 The long bond in the US rises to 7% in the first
half of the year
 Synchronized global growth and continued
prosperity cause the Fed to tighten monetary
conditions.
 Capital investment continues to trend higher and
technology is the main beneficiary.
 Presidential elections, true to tradition contribute
to another positive year for the markets and an
extension to the already un-matched bull market
run.
 Elimination of pooling method of accounting
sparks final major run in M&A activity. (2000
may go down as the year of the mega-merger).
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
Something funny happened on the way to a slowdown in the US
economy, it didn’t happen. While everyone applied what goes up must
come down economics to their analysis, the world’s largest economy
quietly went about its business. All indications point to another
excellent year of economic growth in the US, with some minor signs of
a slowdown in a few select areas.
US Corporate Spread
The yield curve has undergone significant steepening…
Since last year at this time and since even just one month ago, the yield
curve has steepened indicating a bond market that expects economic
growth. Even with short term yields on the rise given the markets
expectation of a short term rate hike, the 3mth to ten year part of the
curve has priced in healthy growth for the US.
With a falling Corporate/Government spread…
US Yield curve Shift Dec
1998 - Dec 1999
The spread between ten year government issues and comparable
corporate bonds has fallen significantly. This gives an indication that
investors are willing to take on corporate risk in an environment where
they think profits are likely to improve across the board.
And a positive outlook for capital spending…
Now that the Y2K budgeting is complete, most companies will be free
to concentrate their efforts on increasing their competitiveness through
technology investment. We expect 2000 to be a good year for
companies which can provide a competitive edge to their customers.
Global Equity research
US Consumer Confidence
9
With consumer confidence at near record highs…
While the high levels of current consumer confidence may give some
reason to pause, the future outlook of consumers remains bright. The 12
month consumer expectations index has just put two months of
increases together after going sideways for most of 1999.
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
Makes for positive growth,
remains manageable...
where inflation accelerates, but
Taken together, there appear to be a number of factors to support
the notion of strong growth continuing in to 2000. Combined with
some of the global and technological factors of which we spoke in
the overview section (Globalization, technology, capacity
utilization, commodity pricing etc.) a likely early year rate hike,
along with a dampened mortgage environment will work to keep
inflation at bay. These factors among others should provide the
economy with the impetus to continue growing at above trend rates
for at least the next 12 to 18 months.
And make 2000 a positive year for technology and cyclical
stocks.
Global Equity research
The early part of the year is likely to see some inflation talk and
potential rate hikes thus putting some pressure on high PE sectors.
Once the inflation fear is eliminated however, these sectors should
provide the leadership which we saw for much of the last four
years. In addition, the acceleration in the global economy should
bode well for cyclical US companies operating abroad, as well as
commodity based cyclicals who will likely benefit from the
stabilization of commodity prices over the coming year.
1
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
Europe
• Key Themes
1999 Stock Index
Performance*
CAC 40
51.12%
SMI
5.71%
DAX
39.06%
FTSE
17.81%
*in local currency
Global Equity research
CAC, SMI, DAX 1999
1
 Economic expansion picks up speed, thanks in
part to 1999’s Euro weakness.
 Risk in inflation is to the upside as structural
friction in European labor markets and potential
oil price pressure seep through.
 Rates rise in the early part of the year, both to
combat inflation and establish ECB reputation.
 Internet development accelerates to a new level
and becomes the key technology investment on
the continent.
 Capital spending increases slightly, with
significant gains in technology.
 Consumer confidence remains high, and equity
market awareness continues to grow.
 Under performing markets Switzerland and
Germany outperform Euroland on strong moves
in industrial, commodity and Pharmaceutical
stocks.
 German tax reform represents a significant
milestone for German and European politics.
 Euro strengthens over the year as economic
growth closes some of the gap on the US.
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
We believe that 2000 will be a year of strong growth in the
European core. We see little reason in the immediate for the
economies of the continent to deviate from these expectations.
That said, 2000 could be the catch up year for those markets
which underperformed in 1999.
Yield Curve Dec.98 Vs.
Dec. 99
Switzerland was a relative under-performer…
Due to the more cyclical and pharmaceutical make of these
indices, they tended to underperform their Euro-land counterparts.
Given the cyclical rebound currently underway and the depressed
state of pharmaceutical valuations we would expect this
underperformance to decrease.
Where spread and yield curve analysis points to growth…
Euro Vs. Dollar
Much like the US, the yield curve in the EU has steepened
significantly since this time last year and over the past month. In
addition, corporate spreads have come down substantially, and
nearly every nation has increased its outlook for growth.
Which bodes well for profit growth and cyclical expansion…
This year profits in Europe are expected to grow at 12-14%
outpacing those in the US which is particularly impressive given
this year’s difficult comparisons. Growth has been aided by a
weakened Euro, which has placed select cyclical and industrial
stocks improved competitive positions.
Global Equity research
European 10 yr. Rates
1
And may finally mark the end of falling employment…
The employment outlook in Europe and especially in France and
Germany is starting to look good. Such a development will leave
many consumers happier to spend and signal a move back into
consumer stocks in Germany.
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
And justify the need for further restructuring and consolidation
in EU industry…
Consumer Confidence
Future Outlook - Europe
The restructuring process in the EU, which we have focused on for
a number of years, is now truly beginning to bear fruit. The rate of
change in EU industry should continue to accelerate and will be
driven even faster by technological innovation on the continent.
Recent developments in the M&A arena (i.e.. Vodaphone’s hostile
takeover attempt of Mannesman) as well as accelerated trends in
capital investment should work to further strengthen the quality of
EU businesses and capital markets.
Which will help to sustain high consumer and business
confidence…
Both current and future measures of confidence indicate a positive
environment for business in Europe in 2000. With order books at
near record levels industrial growth in the European core is set to
accelerate in 2000. Coupled with improved outlooks for both
capital investment and hiring indices this should provide support to
consumer confidence levels over at least the next 12 months.
Global Equity research
Euro Order Book
Growth
1
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
Japan
• Key Themes
1999 Stock Index
Performance*
Nikkei
36.79%
Topix
58.44%
*in local currency
Nikkei 1999
 Economic growth continues to better
estimates, although still a far cry from the rest
of the world.
 Unemployment bottoms in 2000 setting the
stage finally for a consumer led recovery in
2001.
 Capital spending by corporations finally
bottoms led by the growth of technology
investments.
 Narrow focus of market expands slightly to
include some cyclical and consumer stocks,
while technology, communications and
restructuring companies remain popular.
Global Equity research
Nikkei 10yr Chart
1
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
1999 was a significant year for the Japanese economy and markets.
After nine years of decline, the Nikkei 225 rose almost 76% on the year
and the economy appeared to have solidified. Our view at the beginning
of the year was that three driving forces would define the year. Massive
government spending would support capital investment, while corporate
restructuring would rationalize company balance sheets and a genuine
move towards change would take hold. This is exactly what happened
and it has laid the groundwork for continued economic prosperity in the
country.
A very Narrow Market recovery...
So where to from here? The Japanese economic recovery has been
marked by very narrow financial markets focused on restructuring,
financials and technology.
Unemployment - Japan
With little domestic support…
Almost 70% of net buying in Japan in 1999 came from US investors
looking to diversify out of dollar holdings. The key for 2000 will be the
support of domestic investors, as large fixed term postal savings deposits
come to term in 2000 (¥58trn) and 2001 (¥58trn), and may be redirected
into the market for higher returns.
Where restructuring continues to bring down employment…
We expect unemployment to continue to worsen in 2000, although it is
likely that the bottom will be found some time this year. As the
restructuring push gains momentum (and it will) downsizing will
increase and jobs will be lost. We remain confident however that in the
end this rationalization will create a lean and mean Japanese industrial
machine.
Weighing heavy on the minds of consumers…
Capex - Japan
But as we see the light at the end of the tunnel, consumption should start
to rebound, and as markets tend to anticipate such rebounds, we would
expect retailing sectors in Japan to show relative strength.
Global Equity research
But a rebound in corporate earnings may bode well for capital
investment ….
1
This year the non-manufacturing portion of Japanese earnings increases
over 11% and earnings growth looks to be solid for 2000. Many
companies are flush with cash (having spun off businesses) and are likely
to reinvest that money with a focus on technology spending, which has
suffered enormously during the nine year recession. We think that
capital investment may be bottoming.
Which may result in a slightly broader market…
While the markets will likely remain focused on technology and
restructuring, we feel that some potential exists for value adding
industrials and consumer stocks, thus a slightly broader market in 2000
than experienced in 1999.
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
Emerging Markets
• Key Themes
1999 Stock Index
Performance*
Brazil
151.93%
Korea
82.78%
Indonesia
70.06%
*in local currency
Global Equity research
Brazil, Korea, Indonesia
Mkt Indices 1999
 Currency devaluation unlikely in Brazil and
China
 SE Asian markets provide much less upside
potential in 2000 as “easy” money has been
made
 Capital spending in technology - most notably
telecommunications drives the economies
 Demand returns to pre-crisis levels, and
provides potential upside to global consumer
stocks
1
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
Investment Outlook
•Key Themes
Capital Investment & Restructuring:
 Global industrial recovery favours global
companies as well as European and Japanese
cyclical companies where economies are
accelerating.
Synchronized Global Recovery:
 Synchronized global growth should return global
consumer brand names to strong growth, and
support continued move in luxury brands.
Financials with global reach should also benefit.
Technology, & Life Sciences Growth:
 Capital
Investment
continues to favour
technology/Internet development.
 Aging population and medical technology
advances spur life sciences growth.
Commodity Price Recovery:
 Supply/Demand situation supports price rises in
Global Equity research
many basic materials.
1
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
Valuation
Europe looks good...
The market movements of the past few months have pushed valuations
to seemingly untenable levels. From New York to Paris, income, asset
and cash flow based valuations have been stretched to their limits.
Regional valuations
2000 EPS Growth
PE ‘99 ‘00
Europe
France
Germany
UK
Switz.
Sweden
25x 15% 16%
26
23
23
29
29
22
15
7
15
24
20
21
12
12
23
Japan
na
13
16
USA
24
17
12
Est. from Morgan Stanley Dean Witter research
In an environment of rising rates such valuations put the near term
outlook for the markets at risk. We feel that while the mid to long
term outlook remains positive, market performance over the near term
is less clear.
What is clear is that outside of the US GDP and earnings growth
estimates are on the rise. Europe and Japan should enjoy accelerating
earnings growth as we move through 2000. In Europe the German
market appears to be the most undervalued, with significant earnings
growth acceleration and at the lower end of valuations.
While the US earnings growth is slowing...
After the two years of crisis (1997 - Asia, 1998 - LTCM/Russia), many
US companies had very easy comparisons in 1999. In 2000, the
comparisons are more difficult and although above trend line growth
looks set to continue, we are wary of the potential for earnings
disappointments in some sectors - technology and money center banks
come to mind.
Therefore we feel that growth in the US market remain very selective,
and it will be necessary to focus on stocks where earnings growth is
accelerating, not slowing, and where top line revenues remain solid.
High debt and low cash earnings would also be of concern in a high
interest rate slowing revenue environment.
Global Equity research
And Japanese restructuring is starting to pay off….
1
Japanese companies after a nine year slump, have finally begun to
realize significant operating earnings growth, and in 2000 it will
accelerate. Valuations in this market are difficult to compare, since
PE’s are still very high given nascent stage of growth in most
corporations
Making for solid foundations for positive performance in 2000…
While our near term outlook based upon current price levels is
negative, over the remainder of the year, earnings growth should act as
a support to valuations.
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
Sector Valuation
Where are the profits?
Growth expectations
by Sector
Energy
Basic Materials
Technology
Transportation
Consumer Services
Telecomm
Healthcare
Capital Goods
Consumer Noncyclicals
Finance
Utilities
Consumer Durables
%
33
33
31
26
18
16
14
13
13
11
10
4
*I/B/E/S Estimates for 1999/2000
Valuation by Sector
Global Equity research
Sector
1
Energy
Basic Mat.
Technology
Transportation
Consumer Srvc.
Telecoms
Healthcare
Capital Goods
Consumer Stpl.
Finance
Utilities
Consumer Dur.
1999
PE
32
25
36
15
30
30
31
26
30
15
15
22
4yr
Avg
29
27
32
16
25
30
35
26
34
17
17
20
2000 represents a significant change from years past, as basic
materials and energy sectors represent the highest potential growth
areas for the year. As usual technology remains among the top
three, and remains in a secular growth phase which has a number of
years yet to run. The high marks for the outlook of cyclical stocks
underlines the market’s expectations for a global recovery.
In terms of valuations, the chart bottom left shows the current and
historic valuation levels by industry sector in the US S&P index. It
is clear that the run from Q3 1999 in the cyclical sectors of energy
and basic materials, has priced some of their growth in, although the
basic materials sector is still undervalued based upon historic levels.
Also, financial, healthcare and consumer staples (global consumer
names, defensives) appear undervalued based upon historicals,
although a case can be made for the pharma stocks given the
slowing of earnings growth from past levels.
Valuations in Europe, while slightly higher due to accounting
reasons, represent similar valuation levels in most sectors.
However, the levels of restructuring, M&A activity and potential for
earnings growth, make a focus on non-US companies an important
one for the upcoming year.
Given our economic outlook and earnings growth analysis, we will
continue last year’s focus upon technology, global industrials, oil
services and to a more selective degree pharmaceuticals, financials
and consumer cyclical names. This year we are shifting focus back
to global consumer branded names (an undervalued sector in our
view), as well an increased focus on basic materials, notably
chemicals and some commodity plays.
The key to our stock selection remains our focus on our five vector
analysis of management, focus, innovation, leadership and
fundamentals, with as mentioned an increased focus on innovation
and the use of modern technology to improve business processes.
*Bloomberg L.P., based upon current
year’s earnings
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
Disruptive Technology*
An Analytical Tool
The Theory:
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Disruptive technologies -- those products, processes, and services that
threaten and often prove fatal to established industry players -- can
arise in any market. Throughout history society has been forced to deal
with their consequences, good and bad.
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Not all innovation is
disruptive*. Some such
as just in time
inventories, disk drive
I/O speeds, or credit
card technology simply
sustain improvements in
customer services, thus
increasing the advantage
of incumbent market
participants.
A recurring event...
Disruptive technology*
however, often
completely eliminates
the advantage of
incumbency,
transforming or
eliminating whole
industries and often
creating new ones where
none existed. Some
more recent examples
include:
Which has accelerated...
•Automobile
•Telephone
•mini-mill steel factories
•Discount retailing
Semiconductors
•Wireless
communication
•Managed Care
(HMO’s)
•Internet retailing
•Internet brokerage
•On-line supply chainmanagement
•Web Hosting
•Online advertising
•Web caching
Its tentacles reach out across borders, race, religion, industry,
companies. It has the power to transform culture and business alike
and has thus far proved to be a solution looking for problems.
Most often the established leaders in their field are caught flat footed
by these events, and find themselves swallowed up by their smaller
more nimble competition. Little did the church (once the master of all
print) realize that the Guttenburg press would remove their monopoly
on information. The horse drawn carriage industry was instantly
destroyed with the advent of the automobile.
Television had
substantial impact on radio and newsprint and the personal computer
nearly put IBM out of business.
Over the last century, we have been witness to probably the fastest
growth in innovative technology that the world has ever seen. And
today we are privy to perhaps the most widespread, pervasive force of
change we have ever seen: the Internet. While the technology world
produces many disruption applications that have liitle to do with the
Internet, no other innovation has cast such a wide net, affecting
business, politics and society alike.
So what is it?
A Global Mainframe...
Less than 40 years ago IBM created the first main frame computer
which revolutionized the way companies worked. It made relevant
information available in greater quantity, more frequently, at greater
speed and to more people within the company than ever before. It was
a data processing and transmission revolution for business.
Much like those 360 series mainframes, the Internet is acts as a giant
computer which provides data collection, processing and transmission
at ever rising speeds to an unlimited number of users worldwide.
*See: The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail,
Clayton Christensen, Boston, MA: Harvard Business School Press, 1997.
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
A communication revolution...
In the most basic terms, the internet is the technological or structural
basis upon which mankind is revolutionizing communications. By
communications we mean all the ways in which people, companies and
machines exchange information. It allows you to check a train
schedule without phoning and being put on hold. It allows companies
to automate their production and purchase functions by allowing
purchasing, production and supplier to communicate automatically
through an established network.
Which can be a tool to increase efficiencies...
While we are
tremendously optimistic
on the long term
implications of the
internet, we are skeptical
of some of the claims
and prediction that some
are making.
As with every such
phenomenon many
oracles have likely
misjudged the future of
this communications
revolution.
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We are wary of some of
the claims made in
regard to pure play
companies, and the
notion of absolute cost
savings of some
companies.
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Up to now the cost of the
build out has been borne
for the most part by the
investor and venture
capitalist community. It
will be interesting to see
the fallout when the cost
of such buildouts make
their way to the
consumer.
In some cases the Internet will transform industry, while in many others
it will simply serve as a means to increase productivity and lower costs.
Harnessing this medium allows companies to streamline operations and
increase margins through automation and increased customer reach.
Or the basis for future growth...
Many CEO’s at established companies have started to take notice. Not
enough. Those companies who refuse to harness it as a productive toll
will slowly wither away. The internet will be transformed from a novel
addition to a core part of every company’s sales, service, purchasing,
personnel, accounting process and everything in between. It will
become a staple, just as having a shopping mall without a parking lot,
so will running a company without the Internet.
Whose costs may be hidden...
Up to now the cost of the build out has been borne for the most part by
the investor and venture capitalist community. The ground breaking
pricing that we have seen on many sites is thanks in part to a healthy
subsidy from the venture capital community. The infrastructure costs
in most pure play dot.coms is therefore not fully reflected in their
pricing. It will be interesting to see the fallout when the cost of such
build outs make their way to the consumer.
Posing questions for investors…
So what does this mean for today’s investor? For us it means a vigilant
watch over innovation. Where are new industries being developed? old
ones broken down? What is the life cycle of the current disruption?
Who stands to benefit and which established companies are making the
move to transform? In today’s high paced environment, this can be an
almost impossible task but a number of shifts are taking place which
may be leaving some companies behind.
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
Forcing them to consider a new criteria…
As part of our research for the coming year, emphasis will as always be
placed upon our five criteria approach, however all of our analysis will
take into account a new sixth criteria: Disruptive technology.
Management
Focus
While many Disruptive
technologies are industry
specific, the internet and
the communications
revolution that goes with
it cut across many
industries.
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From supply chain
management to golf tee
off reservations this tool
creates industries and
helps cut costs, improve
service and increase
margins for companies
in varied industries.
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It has been estimate that
a simple internet based
procurement strategy
can increase net margins
by over 300 basis points
for traditional business.
This type of leverage is
possible across all
divisions of many
companies. Passed on to
customers, the pricing
advantage enjoyed by
companies implementing
such strategies can
create significant market
share gains.
Innovation
Leadership
Disruptive
Technology
Fundamentals
With a focus on companies prepared for the disruption …
But with a heavy concentration on innovation in the area of the
internet. The upcoming year will undoubtedly be marked by a number
of key themes. For the astute investor, however, the common theme
amongst almost all companies should be their internet strategy and use
of new technologies as a competitive tool.
We would be especially wary of companies in the financial, retail,
distribution, business services, supply chain and media industries with
unclear or non-existent internet strategies. These industries are
currently undergoing drastic change and their competitive landscapes
will be very different than they are now in a few year’s time.
While keeping in mind the limits to growth...
Where are we going with many of these developments? In general
disruptive technologies have a massive impact on industry over a
relatively short period. Competitive advantage is taken and high
margins are enjoyed for the early movers. The investor must however
be aware that once entrenched, the acceleration brought about by the
innovation/disruption will slow, and trend line growth will return.
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
We mention this due to the euphoria concerning a number of disruptive
technologies as currently reflected in the stock markets.
And keeping a skeptical eye on the long term...
In the telecommunications equipment sector the broadband issue has
enjoyed significant coverage. From DSL, to Cable and Fiber Optics
every company is attempting to reach the web surfer and provide fast
service. While our clients and technology fund are riding this wave of
growth, we are open to the notion that only so much fiber can go into
the ground, and as with all such things companies tend to build out too
much rather than too little. When the day comes that fiber or copper or
broadband over-capacity exists, it will be too late to sell. We think that
the current build out will continue over the next five years, but at that
point, the top line growth rate assumptions for most of these suppliers
(Lucent, Cisco, Nortel etc.) will revert to trend line growth of 3-5%.
Such a statement may sound like heresy to some, but all markets
eventually mature or are eliminated through some form of disruptive
technology. As investment managers it is our job to ride the wave
when as it rises. We must at all time however keep a close eye on the
future to catch the next wave when it comes.
Allowing only the strong to survive…
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In our view a classic business to consumer business is built upon three
foundations, service to client, products to client (Distribution) and
Trust of client (Brand, Loyalty). Regardless of the outcome of the
technology, companies that can harness these three factors will win in
the end. Today, the pure play internet company has the advantage of
cost on his side. Once volume and infrastructure costs are factored in,
the brick and mortar retailer with a viable internet strategy should
come out on top.
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Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
Sector Analysis:
Technology
Our Sector Choice and Focus List:
We will continue to focus on technology stocks with an emphasis on
application software, wireless communications, broadband networking,
internet infrastructure & services, and cyclical semiconductor plays as
well as a small exposure to select computer makers. While 1999 was
another year of significant technology out-performance, we see little
reason to doubt the underlying fundamentals of the group.
Why Technology:
Broadband Networking:
•Economic Growth
•Competitive Pressures
•Capital Investment
acceleration
•Solid EPS Growth
Focus on:
•Software
•Internet/Computer
Services
•Internet
Infrastructure
•Wireless
•Broadband
Communications
•Semiconductors
We used to split this sector into three parts communication
semiconductors, telecom equipment and networking equipment. The
long awaited convergence in this sector has now more or less arrived and
most companies vie for both networking and telecom business at the
same time. The internet is now an established phenomenon, and the
next move for service providers and enterprise is to increase speed and
reach as many customers as possible. This sector will continue to enjoy
significant earnings growth, until the broadband build-out is complete,
which will not take place for at least five years.
Focus Stocks: Cisco, Nortel, Lucent, Broadcom, JDS Uniphase, Juniper
Networks
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Software
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1999 was the year of the Y2K upgrade, while 2000 and beyond will be
the years of application development and internet build out. With this in
mind we focus on productivity enhancing software, coupled with
internet enablement. While the internet infrastructure build out has been
largely a hardware issue, going forward the need for application specific
software will become more and more important. Competitive pressures
will force companies to more efficiently put to use the equipment which
they have installed. We believe that this will have a positive impact on
software over the next few years.
Focus Stocks: Microsoft, Oracle, SAP, Citrix, Miracle Software
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
Internet: Infrastructure
These stocks, (although they have risen past any even modestly
reasonable levels) represent the future of the information technology
world. The internet build-out is far from complete, and the companies
that make up the backbone of this new tool will continue to benefit
Focus Stocks : AOL, Sun Microsystems, EMC, Exodus, Digex, Inktomi
Covad communications, Fujitsu, Sony
Internet: Service
As more and more companies build out their web based
services/operations, demand for web development consulting and
maintenance will grow. We can already see that demand in most cases is
far outstripping supply, with only a relatively small percentage of
companies with a meaningful web presence.
Focus Stocks: Razorfish, Icon Media Labs, Framfab, Xceed
Wireless communications:
At one time wireless applications represented a small part of the
technology world. Today wireless handset volume has reached over 300
million, and is now estimated to grow to over 1 bln within three years.
We focus on three sectors semiconductors, wireless devices and wireless
infrastructure.
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Focus Stocks: ST Microelectronics, Texas Instruments, Analogue
Devices, Nokia, Ericsson, Kyocera
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Semiconductors and equipment (the non-communication/networking)
are even further down the food chain, and are the engine behind
computers, wireless phones, faxes, etc. They also benefit from all of the
forces driving their “parent” industries. They are not however a 100%
secular growth story. While the industries that it feeds are,
semiconductors is probably one of the most cyclical industries in
existence. The dynamics of supply and demand, today are such that we
are entering the beginning of a cyclical upturn. Capacity spending, turned
completely off since the end of 1997, is now falling quickly behind. As
demand picks up, so will capacity utilization and then prices. Once this
happens are rash of new development plans will emerge and the industry
will again be moving full bore.
Focus Stocks: Intel, Micron technology, Applied Materials, ASM
Lithography
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
Computers:
These stocks, be they enterprise, lap top or home computing benefit
directly and indirectly from all of the effects of the internet. Without
computers, none of the “stuff” that everyone else sells will work! They
have long run unit sales growth between 10-18% every year, and
obsolescence ensures that 25% of them must be replaced annually. We
focus only on two stocks in this sector, both of which possess a unique
method of branding and/or distribution.
Focus Stocks: Dell, Apple
Telecommunications:
The internet revolution is transforming the way in which we communicate
and it is having an enormous impact on the business of
telecommunications. Three areas of growth will drive the business of
today’s telecommunications companies: wireless, data, broadband service.
In addition consolidation in what is currently an extremely fragmented
industry is likely to continue. We focus on companies with significant
exposure to data and wireless and those where M&A activity could bring
significant advantage.
Why Life Sciences:
•Stable Earnings
•Aging population
•Technology enhanced
productivity
•Consolidation potential
•Genome advances
creating new product
cycle in biotech
Focus Stocks: Covad Communications, Equant, Telefonica, Worldcom,
NTT
Life Sciences
Focus on:
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•Cash rich Pharma
•Mid sized take out
targets
•Accelerating EPS
•Limited patent Expiry
•Biotech
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Pharmaceuticals/biotech/Medical Device
While we like the sector, the environment for pharmaceuticals remains a
difficult one. The secular growth fundamentals remain the same, but
medium term challenges lie ahead. With earnings growth slowing slightly,
and potential for adverse political developments in the US we will focus
our investments on stocks where earnings growth is accelerating and
product pipelines are expanding (with little patent expiry risk).
Focus Stocks: Aventis, Roche, Warner Lambert, Medtronic,
Biogen, Ares Serono
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
Financials
Financials. We have always had exposure to the financial sectors, this
year given the expected inflation environment we are being slightly
more focused. Those financials who are capable of benefiting from
global growth such as global money center banks and companies likely
to benefit from the increasing market activity in M&A and IPO
activity, especially in Europe. In addition, those financial institutions
capable of leveraging their business through the technology and the
internet rate high on our list.
Why Financials:
•Global Economic
Growth
•M&A activity
•Regulatory changes
•Emerging market
recovery
Focus on:
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•Internet Strategy
•Global reach
•M&A business
(brokers)
•Insurance (Glass
Steagal)
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Focus Stocks: Merrill Lynch, Citibank, Credit Suisse, Charles
Schwab, Zurich Allied, Nomura
Consumer
Consumer Non-Durables (Global Brands, Distribution)
These companies have traditionally shown steady growth of over 10%
in EPS per year, while displaying the capacity to expand
internationally. They are often characterized as consumer non-cyclical
industries and enjoy a steady demand for their products. The best of
these companies are able to grow earnings at a faster rate than sales and
outperforms the markets during recessions (slightly defensive). Some
of these companies - the global consumer brands - have been hard hit
by the emerging market crisis, and look poised to make a comeback
based upon increasingly positive fundamentals. Their earnings are
linked to growth internationally and this year we expect emerging
markets, Europe and Japan to experience accelerating GDP growth.
Names such as Carrefour, Nestle and Danone will benefit from
increasing consumer confidence and potential margin expansion as
pricing power returns to a limited degree.
Focus Stocks: Carrefour, Macdonald's, Danone, Coca Cola, Gilette
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
Consumer Cyclical:
These companies represent the consumer side of the cycle. They can
de classified as non-essentials (i.e. movies, luxury goods, travel), and
consumer durables.
Why Consumer:
•Synchronized global
economic Growth
•European acceleration
•Positive correlation to
inflation (pricing
power)
•Positive correlation to
rising incomes
•Emerging market
recovery
•Historic Valuation
discount
•Internet
Focus on:
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•Internet strategy
•European consumption
•Luxury
•Global Brands
•Global Reach in
distribution
•Media & Advertising
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Non-essentials/services. This group proved to be a winner in 1999 as
luxury products companies rebounded smartly in face of the Asian
recovery. In addition, our picks in the consumer cyclical department
and discount retailers proved very profitable. This year we will focus
our attention again on European consumption, with a view to those
companies with viable internet strategies. We will also focus upon the
European Media and advertising sectors in an effort to benefit from the
coming internet growth on the continent. Finally, we believe that the
growth experienced in Asia will continue and our luxury group core
holdings will prove to be profitable again in 2000.
Focus Stocks: LVMH, Disney, Canal Plus, Club Med, Publicis,
Peugot, Publigroup
Consumer Retail/distribution
1999 was a record year for consumer confidence and spending,
however many retailers performed poorly throughout the year. The
impact that the internet had on their business was negligible compared
to that which the market thinks is in store for them. Given our views of
the internet retailing world, where the brick and mortar companies with
viable internet strategies and loyal consumer base will come out on top,
we focus on the following companies. They enjoy significant name
brand recognition, have significant distribution capacity model and a
viable internet strategy.
Focus Stocks: Walmart, Federated Department Stores, Pinault
Primtemps, The Gap, Metro AG
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
Cyclical Industry
Infrastructure:
Why Cyclicals:
•Synchronized Global
Growth
•Basic Material price
increases
•Emerging market
recovery
•Oil price recovery
•Increased oil E&P
activity (benefits
services, engineering &
construction firms)
•Capital Investment
acceleration
•Solid EPS Growth
Focus on:
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•Infrastructure
•Energy
•Basic Materials
•Value Added Chemicals
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Our decision last year to overweight this sector paid off handsomely. In
addition, our focus companies continued to invest in the emerging
economies during the crisis. Now as government spending on capital
development projects in these regions increases, it could mean big
business for cement, engineering, turbines etc. Order books in Europe
especially are growing and indications are that many government capital
spending programs are back on track. As growth returns to these
companies, their record valuation discount should shrink. We focus on
companies which either have a dominant position in their industry or who
have successfully transitioned their business to the value added services
model.
Focus Stocks: ABB, Holderbank, General Electric
Energy
We have long held fast to the oil services and energy sector in general.
This year it will finally pay off. With Asia and Japan on the upswing and
oil prices set to stabilize above $20 per barrel, the outlook for refiners and
oil services companies looks bright. We look to the large cap oil
producers who will benefit both from rising process and increased global
demand, as well as exploration services companies whose business should
pick up in the later part of 2000.
Focus Stocks: Royal Dutch, Total, Schlumberger, Haliburton
Chemicals
As with most of the basic materials stocks, chemical companies have
moved quickly over the past few months to much higher valuations. We
think that there is much potential in the group which is defined by three
factors. They are cyclical, hence the overall economic growth rate is key
to their stock price appreciation. Secondly they are very dependent on the
price of their inputs which for the most part is derived from oil, hence the
Copyright Forum Finance Group S.A.
January 2000
FORUM FINANCE GROUP S.A
FFG
Investment Perspectives 2000
price of oil is negatively correlated to their performance. Finally, these
companies are extremely sensitive to the pricing power of their clients and
they often find themselves squeezed between increasing oil prices and
inelastic finished product prices. After two years of increasing input
pricing, things are looking to stabilize in 2000. We therefore would tend
to focus our chemical plays to those stocks which have exposure outside of
the commodity chemicals sector, which provide value added products.
Focus Stocks: Dupont, Kaneka, Akzo Nobel, Rhodia, Clariant
Basic Materials
Our economic outlook assumes global synchronized growth and a modest
amount of price inflation. While not all commodity prices will enjoy
stability, some of the basic materials pricing should get better in 2000. We
look for a slight improvement in aluminum pricing and a positive outlook
for steel and some specialty capital goods companies.
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Focus Stocks: Sandvik, Thyssen Krupp, Bethlehem Steel, Alcoa
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Copyright Forum Finance Group S.A.
January 2000