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Spotlight on: Non-US Equity Investing
Is the Future the Past? European Telecom and Technology Today
March 22, 2001
The sharp downturn in European telecommunications and technology stocks in 2000 has continued through the first quarter of 2001. Investors pondering growth opportunities in these industries must understand fundamental changes now taking place.
There can be no return to "normal" without an understanding of what "normal" really is. This is the challenge to investors looking for a renewal of the high growth levels enjoyed by Europe's telecommunications, media and technology (TMT) stocks prior to the first quarter of 2000.
 Ann Duncan, Russell Non-US Equities Portfolio Manager, notes that "defensive industries did well following the collapse of TMT stocks last year. But they're now selling at very high price/earnings multiples. Investors must decide whether opportunity in Europe lies with the safe havens of 2000 or a return to telecom and technology stocks available at prices far below those of a year ago."
Puzzles and paradoxes
Duncan poses three questions for investors considering European growth opportunities in 2001:
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- European growth appeared to peak in spring 2000. The Ifo Index of business confidence in Germany has continued to fall since then. Yet Europe hasn't seen the abrupt slowdown the US has suffered. In fact, European industrial production rose a greater-than-expected 2% between November and December 2000, according to Eurostat. Can European growth continue?
- Increasing globalization means that a slowdown in the US will affect the rest of the world. How great will the impact on Europe be?
- The US Federal Reserve Bank lowered interest rates twice in January and again March 20. Will the European Central Bank follow suit?
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Alarm bells
Duncan sees investors returning to fundamentals in this period of uncertainty. She finds an enthusiastic proponent of fundamentals in James Rutherford of Fidelity Investment Services of London, one of Russell's Non-US equity growth portfolio managers. Rutherford anticipated last spring's correction and rotated considerable assets into defensive industries, such as pharmaceuticals, food, household products, beverages, tobacco and insurance.
Rutherford cites three alarms that led him to rebalance his portfolio ahead of plummeting telecommunications and technology share prices. The first was a dramatic change in Fidelity's risk profile in early February 2000. The top 10 stocks in Fidelity's funds, normally 15% to 20% of their portfolio, had reached 25% — an overly concentrated position. Second, the breadth of the market was very narrow. Only 20-30% of all stocks in the market were actually outperforming their industries. "That was unhealthy," says Rutherford. Third, analysts were downgrading a number of companies because there were no fundamental improvements in their businesses.
Piercing the bubble mentality
Fundamentals in Europe's telecom and technology arenas are still weak, according to Rutherford, who sees the issues being more structural than cyclical. As a result, investors looking for a dramatic telecom/tech comeback might be disappointed because the previous peak was caused by "massive over investment." Too many investors still believe that the peak in telecom and technology stock prices reflects a normal condition.
Rutherford advises that those price levels were highly inflated. "Investors should not assume a bounce-back anywhere near equal to the past year's decline in share prices," he said. Not only were those share prices illusory but, "compared with earlier in 1999, fundamentals have gotten worse."
Rutherford cites such compelling factors as commoditization in the telecommunications industry. Competitors now offer similar services and equipment, thus driving revenues down. Moreover mobile phone penetration in Europe has surged to over 50%. "We may have had all the exponential growth we're going to see," Rutherford said. He also points to uncertainty regarding the impact of new wireless technologies.
As Europe's telecom service suppliers look more critically at their cash flow, equipment suppliers will also be impacted, since their sales and revenues have been based on customer growth rates of 20% to 30%.
A fogged crystal ball
Historically, Rutherford asserts, the economy of the United Kingdom lags behind that of the US, and the European continent's economy lags behind that of the UK. Europe's growth rates may surpass those of the US now but could slow down in the coming months in response to a sluggish US economy.
Investors looking to the European Central Bank to follow the US Federal Reserve Bank example and cut interest rates may be disappointed. "The ECB tends to look at current data rather than at indicators for the future as the Fed does," Rutherford said. "The ECB's main concern is inflation, since the Euro has been weakened by surging oil prices and $500 billion worth of recent European acquisitions of US companies."
As a result, Rutherford believes the ECB will probably wait to cut interest rates only when the 2% target inflation rate turns down — a move that may be too late to effectively stimulate the European economy.
Where do investors go from here? Rutherford still sees a lot of earnings risk and no definitive bottom to the market. "A number of stocks I own have done well in relative terms even if they look expensive regarding their history," he says. "It's a balancing act. You have to focus on the fundamentals of an industry. The mobile telecommunications industry, for example, can't sustain past growth. The big risk is that investors will want to go back to the good old days — that they have an unhealthy appetite for buying the dips to buy back into technology. Today, investors have to be a lot more discriminating and choose the right individual stocks."
Rutherford also believes that investors will have to learn to live with volatility." The key is to concentrate on fundamentals — earnings and valuations. Big-picture forecasting is so hard to get right."
A simple case for diversification
Ann Duncan emphasizes that diversification lies at the heart of a wise investment strategy. "We saw a rally in European telecommunications stocks early in 2001 and a rebounding Nasdaq during January," she said. "Then telecom and technology stock prices tumbled again. Investors are unable to successfully time the ups and downs of sectors. Good results in Europe will ultimately be more easily achieved through a rationally balanced portfolio."
Duncan looks to Russell's multi-manager approach as the key to finding long-term growth opportunities.
For further information about these contents, please contact Russell Investments Canada Limited.
Copyright© Russell Investments Canada Limited 2001. All rights reserved.
This is a publication of Russell Investments Canada Limited. It should not be construed as investment, legal, or tax advice. The contents are intended for general information purposes only, and you are urged to consult your own investment, legal, or tax advisor concerning your own situation and any specific investment questions you may have.
The opinions expressed by the professional featured in the above article are not necessarily those held by Frank Russell Company, its affiliates, subsidiaries, or distribution channels. While all material is deemed to be reliable, accuracy and completeness cannot be guaranteed. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.
Russell conducts a rigorous manager research process and provides a select set of top-rated investment managers for clients, such as the professional featured in the above article. Russell continually evaluates and re-evaluates investment managers to ensure that our clients receive comprehensive and strategic diversification. We believe that diversification through multiple asset classes, multiple styles, and multiple managers will enhance long-term performance while managing risk.
The Ifo Business Climate Index is a widely observed early indicator for economic development in Germany. Every month the Ifo Institute surveys more than 7,000 enterprises on their appraisals of the business situation and their short-term planning. From these responses to the Ifo Business Survey, the confidence indicator frequently referred to as the Ifo Index is derived.
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