November 1999

Financial Affairs

The financial road towards 2000

1999 have been until now very volatile at the majority of the stock markets with the exception of the far east. The Pacific-rim stock markets have been performing very well. It seems as they have succeeded in the economical turn around after approximately 2 years of recession.

The US stock markets have been very volatile and experienced several ups and downs. Very generalised the year looked like this. January and the first part of February positive, to end of February and March negative and April and half way May were the most positive of the year. The summer months were very flat and moving sideways with now and then a small growth spurt but overall with a negative tendency. To reach new lows for the year in October as the psychology, e.g. the fear of the high stock valuations, and the possible increasing inflation, e.g. rising interest rates, pushed the markets down to the Dow Industrials 10.000 point level. The European markets were more or less following the US trend but remained more positive in general. The far east and the emerging markets were also influenced by the US trend but they could gain back much of what they had lost in the last two years. Especially the numbers in Japan were very promising as the Nikkei 225 reached the 17.000-17.500 level.

The United States of America

The decline of the stock markets in the US were, as mentioned above, mainly based on psychological factors. It is therefore to early to speak about a bear market. As a possible rise in interest rates are now more or less included in the stock market, an actual rise will only cause moderate damage. The Y2K problem could lead to some more problems especially in the last quarter of 1999 and the first quarter of 2000. Y2K remains however to our understanding and estimates more a virtual threat than a reality.

But remember a decline is also an opportunity to get into some new stocks which were before exorbitantly expensive.

The current situation can be better described as that the bull takes a rest to continue at the end of 1999 or in the third and fourth quarter of 2000. The economic fundamentals are still to good to start a bear market.

The threatening inflation and the high stock valuations will remain however a problem in the US even as the actual figures, especially the inflation indicators, are not as bad as expected. The Producers Price Index was higher than expected but they were distorted by the non-inflationary rise in tobacco, car and oil prices. The Consumer Price Index was more moderate and in line with expectations. The CPI will deliver a better, or correct, view on the US economy and that inflation is not yet that dangerous. The majority of the US companies are thereby performing better than expected. They continue to beat the market expectations. These positive indications should lead to some additional growth but nothing of the kind is happening. All gains of one day are being eliminated the next day.

There is some kind of war going on between interest rates and the earnings growth of the companies. The interest rates have a depressing effect on the market where as the good results should support the market. The federal reserve, fed, will continue, with the big stick of rates, to calm down the market with the goal of avoiding inflation. The fed considers the high stock valuations and the fast growth of the stock market as an unwelcome development which could stimulate inflation. Occassional interest rate rises, speeches of the chairman Allan Greenspan of the fed and especially the threat of even more rate hikes depress the stock market. Consequently a very likely movement of the market is, after the 10 to 15 % drop of September-October, sideways with a slight negative trend on the short to medium term. We estimate the Dow Industrials at the end of 1999 in the 10.500 – 11.500 range, but most likely at the bottom side of the estimation. It remains a volatile market with some companies are performing very well where as other are not able to break the trend.

The US economy is hot but not overheated and a soft landing is certainly possible. As is indicated by the production/order estimates for the coming months which estimates a lower production for the next two to three months.

The stock market’s health is further looked after, protected, by the fed. Even if it can be thought that the control of the stock market is not the job of the fed it could be usefull as to forego the creation of a bubble on the stock market. If some air can get out now, the markets could continue with a stable growth in the next couple of years of 15-20 % per annum instead of the very high return of 25-30 % growth of recent years.

The US market

It will be ever more difficult to select the right stocks. Some groups of the economy will continue to outperform the others but it will increasingly dependent on the individual company’s performance if a company is a growth stock or a laggard. We will give some indications of some sectors and about their situation.

The pharmaceutical sector is still very expensive and even if the returns are above expectations and the product pipeline is promising, every negative publication will be used to sell the sector. On the short term the drugs stocks will be flat but on the longer term they will be very promising. A healthy financial position, a promising product package and an increasing group of customers, e.g. higher demand, will make the sector very interesting.

The tech sector is ambivalent, the hardware sector, with exception of Apple and some chipmakers, is depressed by the Y2K threat perception. The software side is divided into general and maintenance/implementation software providers, the likes of Microsoft, CSC and CA, and the application companies, the ERP, internet technology and like group. Were the first group will remain profitable the second group will be depressed by the Y2K problems and contract deferments until the first or second quarter of 2000. The internet provider and E-commerce business group of companies will remain growing in scale and returns. The subscription numbers continue to grow but the e-commerce sales remain a little behind expectations. In general this group will remain positive. The high stock valuations of the internet companies is the only limitation for a strong growth of this sector.

The telecommunication sector will see a stable growth. All will profit from the increased use of telecommunication services by the internet users. Not only voice but especially data transfer will be a major boost to the returns of the telecommunication companies. In this competitive sector only proper management, product management and cost control will divide the better companies of the group which can and will outperform their competitors. The sector will probably not deliver any large increases in stock price as they are occupied in digesting the latest acquisitions and fusions. But we do not exclude a pleasant surprise in this sector. Some of the baby-bells and medium sized operations could become very attractive as they might grow faster than expected. On the medium to long term the telecommunication sector remains very interesting.

The other tech related group are the consumer electronic producers and distributors. This group will be very profitable if they are in the right group of products. The companies in the DVD, flat screen and mobile phone equipment production and distribution will show a very nice growth in the coming quarters. Especially the retailers will profit from the upswing in consumers electronics.

The financials are on the edge as interest rate hikes will undermine the sector but if the Y2K problem is actually depressing the stock market and the inflation indicators remain moderate then there will be no interest rate rise which will be benifial to the financial sector. The financial sector will most likely make good the territory they have lost in the first three quarters of 1999 as the latest scenario is the most likely to happen.

Energy will continue to be one of the best performing groups in the market. The higher oilprice and the increasing demand, winter time in the northern hemisphere and the improved economic situation in South-East Asia, will continue to boost the performance of the energy sector. All parts of the energy chain will be promising, exploration, procesing and distribution will experience booming markets.

The auto/car producers and sub contractor sector will continue to do well. The best years might be over but the next couple of years will not bring to much feared collapse in car sales. The sales in the US might remain more or less the same but the rest of the world will see an increased demand for cars and trucks.

Other sectors like paper, specialist chemicals and even the Caterpillars will see improved sales and a rising stock price. Where as US demand will not see any large improvement, world wide demand will improve the numbers of those companies. A weaker dollar will additionally reinforce their position on the world market.

The Aerospace and defence sector will also experience better times. Especially the defence sector will see after the recent drop in the share prices a clear improvement. Beside the good domestic market these companies will receive more international demand. This moment is the right time to enter this sector as they only can become better.

The European markets

The European stock markets have been and will be influenced by the sideway movement of the US markets, it will not receive any support, upward pressure, from the US like they had in the last couple of years. This will somewhat limit European growth but this could be benificial to the market as overheating and a bubble will be less likely to occur. The majority of the European markets will experience growth as the European economies are improving. Their home markets will become more healthy, the emerging markets improve and the US market will remain stable. In general the European markets are very promising for the coming quarters.

There will be however a clear division in Europe. Western Europe, the members of the European Union, will outperform Eastern Europe. In general Western European countries will grow in 1999 around 2,5 % with a low inflation of 1+%. The growth estimates for the year 2000 will be better as all indicators, production, marketconfidence, export and consumer demand are better than before. The European economy is expected to grow at an average 3+ % for the year 2000 with a core inflation of about 1 to 1,5 %. The countries of the European Union are going to experience a wide based growth in the coming years. Not only the export oriented companies will be performing well but also the domestic markets will see an above average growth.

The forecasts for Eastern Europe are not that rosy. As Eastern Europe has been badly hit in 1998 by the spill overs from the Russian crisis which put an end to the economic recovery after the dissolution of the Soviet empire. The southern part of Eastern Europe have been additionally hurted by the Kosovo conflict in 1999. The Kosovo conflict limited economic activities, destroyed the trust in the markets and increased the government expenditures.

Eastern Europe’s economic performance in 1999 will be lower than expected as the exports are lower than estimated, government expenditures are to high, the inflation remains high and the foreign investments have become lesser since the Russian crisis. Eastern Europe can be divided for the year 2000 into roughly three groups. The first group with an annual growth for 2000 of above 3 %. The second group with a growth of 2 to 3 %. And the third group with a growth of lesser than 2 %. Countries in the first group are Hungary, Polen and Slovenia. The second group, Czech Republic, Slowakia and the Baltic countries. And the third group, Rumania, Bulgaria, Russia, Ukrania and Belorussia. Were the last two even might experience zero growth or even an negative growth figure fo 2000. Where as the Ukrania only has problems with the performance of the economy, Belorussia has additional problems because of the ineffective and incompetent political leadership. The problems in Russia surpass them all. In Russia the problems are about a bad performing economy, political indecisiveness and struggle for positions and even more dangerous, a little war in Chechnya.

The Eastern European economies require a lot of investment and even more time before prosperity will become a common good. Their industries are in desparate need of financial and technology support. The wages might be low but outdated equipment, unproductivity and unattractive products destroys the comparative advantage of this group of countries. Beside many low perfoming companies there are some companies which are capable to compete on the world market but these are mostly foreign owned and operated or they are / were a kind of special case, model, company. But they are to low in number to make an impact on the society.

Beside the wage advantage, educated workforce and flexibility some Eastern European companies remain attractive as a bridgehead into a new market. The best companies have already been acquired but with some additional work and ofcourse investments there are still some good companies available. The first hype in Eastern Europe has been over but on the medium to long term Eastern Europe, especially central Europe, remains an attractive market with a well educated population of around 100 million people.

Emerging Markets

The emerging markets of South-East Asia, including Japan, and Latin America are finally recovering from the crisis of 1997. Especially Japan, South Korean and the majority of the countries in South-East Asia have been growing very well in 1999. The situation in Latin America is improving a little more slower but the trend is and will remain positive.

The Pacific-rim

The improvement of the Japanese economic situation is one of the main causes of the improvement of the whole South East Asian region. After years of low consumer demand the Japanese people finally start to spend more money. The economy is not anymore only dependent on export and government spending. The consumer demand is however not that strong as it could replace export.

Which brings us to the next problem. The improvements in the Japanese economy has not only positive effects. The Japanese currency, the Yen, has become more expensive because of the success. And an expensive Yen undermines the export position and finally the economic growth of Japan. The control of the currency is therefore very important to let the Japanese economy continuing to grow.

There is another problem which might undermine the recovery in Asia, minus China. The U.S. Federal Reserve will try to forego inflation in the U.S.A. by limiting the availability of money, e.g. rising interest rates. If this happens the repayment and interest payments of US dollar dominated debts will become more expensive and the availability of investment capital will become more scarce. Two developments which are highly unwelcome to a region recovering from a financial crisis.

The improved Japanese economy, the improved internal political and economical situation in the majority of South-East Asian countries and the increased demand form the west stabilised and stimulated economic growth in the region. This will be boosted by the willingness of investors to re-enter the region.

All countries in the Pacific-rim region will be part of and benefit from the recent economic recovery with the exception of North Korea, China and Indonesia. The internal problems, political, economical and social, of these countries make a recovery very unlikely. Some individual companies in China and Indonesia might do very well but they are clearly the minority. On macro-economic level there are corruption, incompetent management, bad loans, unproductive protected industries and many more problems which only can be dealt with harsh measurements which are unwanted by the ruling elites.

Indonesia might be the only one which is going to introduce the necessary changes but it remains to be seen if there are enough changes and more importantly if they are really carried out.

The other Pacific-rim countries, South Korea, Taiwan, Japan, the Philippines, Malaysia, Thailand, Singapore and with some luck Vietnam are more promising. They are on the road to recovery and will most probably not be caught in the same problem of before 1997. Short term debts, bad loans, nepotism and unproductive investments.

Direct and indirect investments in the above mentioned countries will be secure and profitable again but not as profitable as in the pre-1997 days.

The best performers in the region will continue to be Australia and New Zealand. They will profit the most from any improvement in the region as they will regain markets that were lost during the crisis. The recently acquired new markets in Europe and north America will be further developed and ofcourse Australia will benefit from the additional revenues of the Olympic Games in Sydney.

Latin America

Latin America had its share of problems with the currencies and economic performance. Countries like Brazil and Venezuela have experienced currency devaluations while the currencies of Mexico, Argentina and Chile have come under pressure. For both however it is valid that they experienced a fall back in growth as internal and external demand and investments into the region diminished rapidly. The situation in the other Latin American countries, with the exception of Colombia and Ecuador, have been depressed by currency pressures, lower demand and lacking investments. Colombia is a case on its own as the economy is nearly destroyed by the civil war. Ecuador is on the other hand in deep problems because of the bad government budget situation and the pressures of to much foreign debt.

The Latin American countries, again with the exception of Colombia and Ecuador, have experienced a slow recovery. As the international situation improved demand improved. The internal budget problems and the pressure on the currencies have been alleviated by a combination of government action and IMF support packages.

As long as there is no medium to large increase of the interest rates of the U.S.A this positive economic development will continue. The economic recovery will be slow but stable. The following countries with the largest economies in the region will develop best, the best and fastest to the slower are lined up, Chile, Argentina, Mexico, Brazil and Venezuela. The other countries, again with the exception of Colombia and Ecuador, will follow the five countries mentioned above at about the same pace as Venezuela. Where as the development of Honduras, Nicaragua and Guatamala will be the slowest as they have still not recovered from the destructions of hurricane Mitch.

In general terms Latin America is improving but slowly as the structures of the government, the companies and the economy do not allow for a fast recovery. On the medium to long term Latin America is worthwhile to get your attention and make some investments, especially indirect investments could be profitable. Direct investments into the region,with the exception of Argentina and Chile, are more insecure because of the political and legal instability in some countries. Consider the problems MCI-Wordlcom and AES are facing in Brazil after acquiring a company in that country. A treatment which a Brazilian company would not receive but because it would be more expensive to withdraw from these investments they have no other option then to accept.