January 2001

Portfolio management in the new century

The new century

After we have entered the new millennium with the year 2000, the year 2001 signals that we enter the twenty first century. A new century which hopefully delivers the good things of the previous century but without the large number of conflicts including two world wars of the last century. The year 2001 will be a new chance to the world, might that be the political, economical or the personal dimension, to achieve great things which would make a difference.

The last two decades of the prevous century proved to be very beneficial for the investor. The U.S. economy experienced a booming market lasting longer then ever before, Asia had their incredible development in the nineties which unfortunately ended in the Asian crisis of 1997 but it showed the economic potential of the Asian region and finally Europe started slowly to recover after the slowdown since the end of the cold war. This positive economic environment has been very beneficial to the growth on the stock markets around the world. Year after year new highs were reached and records broken. The Asian crisis and especially the fall of the tech stocks in 2000 and the slower growing U.S. economy ended the fairy tale for the moment.

This correction of the stock markets punched the bubble of the ever improving, growing, stock market. The values returned to more acceptable levels at which a purchase would make sense. The year 2001 will be most likely flat and volatile with just a small number of stocks able to show an above average growth. It is an emotional market were small incidents can result in sell offs and heavy buying on other moments but not as relentless as in the heydays of the IT fever. The slowing world economy will suppress abundance growth but nevertheless there are some hopes for improvement.

The market in general

The stock markets of the world have shown a very differentiated view. The U.S. and European stock markets were sligthy negative, the big tech sell out, but a number of overseas markets, the Asian Tigers and the emerging markets, did deliver some better results. The recovery of the Asia crisis of 1997/98 could continue despite the worser results in the western world and some equity problems in some emerging markets.

The stock markets in Europe and especially in the U.S. have seen a dramatic fall in value because of the flight out of the tech stocks and the waiting attitude of the institutional investors to re-invest the available money. The difficulties in selecting a new president in the U.S. and the increased oil price had also a part in the depressed market situation.

The year 2001 could however deliver a turn around to the fortunes of the U.S. and European stock markets. The U.S. stock markets will most likely be positively influenced by the election of the new president, especially George W. Bush seems to have the trust of the investors to be good for business. But especially the next conditions will be beneficial for the stock market. The probability that the Federal Reserve, Fed, will cut the interest rates, the economy seems to manage a softlanding, a large number of the businesses seems to be confident that the earnngs in the first quarter of 2001 will increase by at least 10 % and finally the market has most likely bottomed as it is oversold.

The election of George W. Bush as the new president of the U.S. will be, according the election program, beneficial to the financials, drugs, tech, HMO and defence sectors. The Fed will very likely be certain that the inflation is under control, the recent decreases in sales and the slow down of the economy will probably allow the Fed to lower the rates. The expectations of positive earnings figures and the oversold market will encourage the institutional and private investors to re-invest and invest new money in the stock market.

The European stock markets will also see somegrowth in 2001 as the economies are improving, unemployment is coming down, the common European currency, the Euro, will most likely improve in value and the goverments are busy to improve the business climate in Europe. The further integration of Europe will be a boost for the economy of Europe and will be equally positive for the stock market.

The Asian Tigers and emerging markets will also continue their recovery as the demand and earnings will increase, the companies are more or less restructured and the governments are doing their best to improve the business environment, e.g. less corruption and nepotism, better tax and corporate legislation and lesser direct government involvement in business affairs.

Problems and consequences

There are however a number of emerging markets like South Korea, Indonesia, Turkey and Argentina which have equity problems and need support from the IMF. This might damage the growth of the stock market as the currencies will be under pressure and a decreased demand in those countries. The profits of the stocks will be surpressed by the lower demand and will be eliminated by the currency devaluations.

Parts of the emerging markets call for caution and the slowing world economy could make it for these countries more difficult to solve their problems.

The world is however delivering a very diverse picture with good, mediocre and bad countries and companies. We therefore expect in the end a small positive development The small improvement of the western stock markets and a continued improvement of a number of emerging markets could lead to an improvement of the majority of stock markets.

The future growth will be most likely spread along a larger group of sectors and will be smaller than before. But one thing is certain it will not be an easy ride. Uncertainty, conflicts and pre-announcements/warnings will create some volatility in the market.

The future might be positive but there are some negative influences which could play a larger role as they should. The inflation is more or less under control in the west but this could get out of control as the oil prices remain high, the costs are increasing, demand is getting lower and the economic growth is becoming much more less than anticipated. The negative possible developments are present but they do not need to become real. What road will be taken will depend on many factors, at the moment we are the cross roads. But we are inclined to believe the positive scenario.

The Portfolio

The year 2001 could be a very turbulent, the market will show some ups and downs, will move sidewards and probably move up. All is dependent on the company, sector, country and region. Some of these developments have a larger repercussions and have an effect on the whole market.

In this market you should spread your investments over different regions and sectors/industries to minimise any negative developments on your portfolio. The best way to play the stock market of 2001 is to invest in mutual funds which are spread by region and sector. Individual stocks are more risky as just the happy few will be in a position to acquire such a diverse portfolio and get the necessary attention to react on possible developments which require quick changes to the portfolio. The average investor is better serviced with a number of mutual funds.

The portfolio is of course dependent on the time horizon of every investor, e.g. how many years you want to invest. But the rule of the thumb is that you increase your number of stocks as longer you invest and you lower the number of stocks and increase cash and bonds if your investment horizon is short. (See for a full account of investing models and region allocation our January 2000 report which is still valid for 2001)

You can invest into stocks or into mutual funds. Mutual funds are the preferred road if your amount of money to invest is relatively modest and if you want to invest in Asia and other emerging markets. In the U.S.A. and Europe you can invest in stocks as the choice, information, trading companies and the legal system are clear and well secured. Asia and the emerging markets are another ball game where you need more knowledge and especially reliable trading houses and legal systems to be safe with your investments. And ofcourse survive the currency changes which might destroy all gains overnight.

The U.S. portfolio

The portfolio should, as a direct investor or mutual fund investor, include the following sectors/companies. These will have a big chance to show an above average growth and secure your investments against any possible deveopment.. Our selection is based on long term growth potential of the companies.

The sectors we prefer are technology, oil/energy, medical/drugs, financials, insurance, airlines and some defensive stocks like food and utilities.

We still like technology as it still has a lot of potential on the product and on the earnings side. The tech sell off was justified considering its Earning Per Share ratio and its value in general. The tech/ICT sector remains one of the most promising sectors especially after the sell off. If the tech market bottoms it will be a golden chance to get involved in a sector which has a lot of potential for the future.

There is however a big difference between the several tech companies. Just a few have the potential to survive in a smaller and more competitive market. The internet industry, market, will change dot com is not a guarantee for success, instead the companies need something to offer and show results. The internet should be looked at as an enabler, a system to do business, to improve the process, as a part of the business. The internet should strictly viewed as a support instrument in operations, sales, marketing, communications and research. And not as the subject, the raison d’etre, of business. With the exception of an internetprovider but they will have a number of difficulties of their own with gaining enough business, earnings, to be attractive for investors

In the processorgroup we like Texas Instruments, Intel, AMD, Xilink and Applied Materials. They should be able to regain their good performance of the last years. In the hardware we like Dell, Sun and Palm. In the software group we like Microsoft, Adobe, Red Hat, Linux VA and Oracle. In the integrator/consultant group we like CSC, Cisco Systems, Juniper, Sycamore, IBM and Nortel. In the communication group we like Nokia, US West, Qwest, BellAtlantic and Qualcomm. The tech group will not bring results in the first half year but in the second part of 2001 they could regain their strength.

The tech group will further introduce a new very big opportunity for the future. The internet has brought new technologies but they are not yet mature enough to deliver the big profits. The future will belong to the companies who are able to deliver a real time connection/exchange between the producer, seller and customer triangle without the interference of data storage and warehouses. In short, an extension of chain management and Enterprise Resource Planning into the full product cycle. Only more flexible in applications and inter and intra company in structure. A company like Cisco should be able to play an important role in this development.

Oil and energy and the supporting companies will probably also continue to grow in 2001. The big integrated oil companies like Exxon, Royal Dutch/Shell and British Pertroleum but also the offshore/service companies like Diamond Offshore, Halliburton, Baker-Hughes and Schlumberger could belong to the winners. As the oil price will be levelling at around 25 U.S. dollar the earnings will remain buoyant.

The medical/drugs sector will also see an improvement in 2001. The pharmaceuticals will finally return to the winning side after two disappointing years. Companies like Pfizer, Merck, Johnson&Johnson, Schering Plough and Bristol Myers Squibb could be among the winners. The shares of the HMO’s will also show better results as the restructurings are finally over, the value bottomed and the investor is regaining trust in the hospital sector.

The financial sector is also on its return as it is behind the market for the last one and a half year, the Fed will most likely ease the interest rates and a number of financial companies have delivered a nice return in the last year. The large global integrated financial institutions like Chase, Citigroup, J.P. Morgan and State Street will be very promising. But also the large trade houses like Merril Lynch, Morgan Stanley DW and Goldman Sachs.

The insurance sector is also becoming a profitable sector.with companies like AIG, Allstate and American Express.

The airline group is also increasing its position as the passenger and freight levels are improving and the price of the tickets could be brought in line with an oilprice of 28 to 30 U.S. dollar. Companies like AMR, United and Southwestern could belong to the best performers of the group.

And finally we like a number of defensive stocks like Heinz, Sara Lee, Pepsico, Colonial Gas and Eastern Utilities. You could also consider to ad companies like Procter & Gamble and Safeway in the defensive play. They offer very likely a good return and offer an opportunity to survive another sell off.

In this volatile and uncertain market it is important to be involved in the defensive stocks but be aware of a shift if the economy gathers pace. By then it will be time to shift into more more offensive stocks in the ICT sector.

The European portfolio

The European market is much more fragmented as each country has its own stock market and companies. The market is coming together but some companies are still to much focussed on the home market instead on the European and world market.

The majority of the companies and the governments are improving their policy and we expect a lot of this development but the changes are slow and could be interrupted by a number of causes.

In all Europe will be a promising market with a steady growth for the next couple of years. It will most likely be more profitable than the U.S. stockmarket.

The sectors we like in Europe are financial, oil/energy, tech/coomunications, food and drugs. We prefer the big caps as they can offer the stability to survive the ups and downs of the volatile stock market.

The financial sector will profit from the European integration as it will increase the business, it opens up new opportunities, the general improvement of the European economy and the consolidation in the sector. In Europe we like firms like BBV Argentaria, Deutsche Bank, Societe Generale, Fortis, ABN-AMRO, ING, Royal Bank of Scotland and Banca di Roma.

In the insurance group we like Allianz, Muencher Ruck, and Generali Ass.

The oil/energy group will also be very promising with companies like Royal Dutch/Shell British Petroleum, TotalFina-Elf and E.ON.

The tech group is also offering some good companies in Europe although smaller in number and with the need of some patience. Companies which will probably offer good results are Alcatel, Cap Gemini, Siemens, SAP, Infineon, CMG, Nokia, Logica, Sage and Invensys.

Closely related to the tech are the communication companies. After a really disappointing year for the telecom sector we expect some improvement. British Telecom, C&W, and Deutsche Telekom could offer some growth potential. The same is valid for VNU who is ever more becoming an internet enabler/service company with above average prospects.

The more defensive stocks we like in Europe are Nestle, Numico, Danone, Diageo, Cadbury Schweppes and Unilever. Despite the growing market we expect these food stocks to be able to follow the growth of the market and more importantly keep or even increase in value if the worst case scenario might come through.

Finally the drug companies will also benefit from the improving market and the increased opportunities in the world. Companies with good prospects are Bayer, Glaxo-Welcome, SmithKline Beecham, Roche and Astra-Zeneca.