Following 1998 in which earnings and sentiment suffered from the economic turmoil in Asia, this year...
Following 1998 in which earnings and sentiment suffered from the economic turmoil in Asia, this year has seen a strong rebound. In the recently reported third quarter, S&P 500 earnings were up 20%, the strongest quarter for many years. This growth was driven predominantly by the larger new-economy sectors of technology (up 35%) and telecoms (up 24%), and we continue to focus on these sectors despite their already impressive growth.
A clear picture is emerging of a new business landscape developing at a speed unimaginable a decade ago. Looking at those key technological areas that are driving the global business revolution and increasing productivity, one fact stands out: America dominates the world marketplace in leading edge products and services. For example, industries seen as the prime growth areas of the next decade - PCs, networking, software, data storage, internet services and IT services - all are heavily populated by world class US business giants such as Dell, Gateway, Cisco, Microsoft, Oracle, EMC, AOL, Yahoo and IBM. Moreover, the US has proven time and again that whatever unforeseen opportunities and changes lie ahead, American companies are more than likely to emerge quickly to capitalise upon them.
This story is not confined merely to technology; other potential growth areas such as healthcare are largely dominated by US companies, with Pfizer and Warner Lambert two of the best prospects in the sector.
The potential of these companies, though, is already widely recognised and much of this growth is already factored into US equity valuations, which from a historical perspective remain high. These valuations, however, are still not excessive when one considers, for example, that on-line advertising and direct selling are forecast to generate $300bn of revenues a year within three years. Nevertheless, individual stocks are susceptible to sharp collapses if they fail to meet these high market expectations, and this is an experience already familiar to some of the biggest names in corporate America, such as Xerox and Gillette.
The Mercury American Fund applies a tight analytical focus to detailed historical financial data. Take the example of Compaq: the company was able to deliver an impressive record of top line revenue growth between 1996 and 1998, providing a strong boost to investor sentiment and the stock price. This, however, belied a surge in days receivable late in 1997 indicative of a weakening supply chain and consequent heavy decline in net income growth, which ultimately saw the stock lose over 50% of its value.
Recent contributions to the Fund's performance came from Texas Instruments, Warner Lambert, JDS Uniphase and America Online. Another long-term contributor to the fund's performance has been the data storage company EMC. Strong demand for data storage, driven by the internet, has driven high profit growth recently, which has been matched by strong stock performance.
Our overall approach is very much bottom up and while we have preferred long-term growth companies we are not constricted by any one style of management. This means the fund is likely to own some companies considered to be value stocks if we believe they are likely to outperform the market.
The Mercury American Fund has 34.7% of its portfolio in its largest 10 holdings. Among these are General Electric where it has a 6.2% portfolio exposure followed by Microsoft at 6.1% and Cisco Systems at 3.3%. Its largest sector exposure is 21% in technology companies, followed by 14% in finance, 12% in communications and 11% in each of capital goods and healthcare.
Peter Kaye is associate director at Mercury Asset Management
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