While the last 12 months have been difficult for the troubled technology, media and telecoms sector, long-term prospects remain positive for well financed companies with strong market positions
It has been another torrid year for technology-related stocks. The events of last September compounded the problems the sector was already experiencing. Capital expenditure plans have been put on hold, while the risk premium and cost of capital has increased.
The question on investors' lips is where the technology, media and telecoms story goes from here. I believe the long-term prospects for the sector remain positive for the well-financed companies with strong market positions. The signs, on the face of it, look pretty good.
The technology-laden Nasdaq has gained more than 30% from its 52-week low last September, as investors appear confident the sector will bounce back.
However, people should not get too carried away. Yes, the long-term picture for technology is still intact, but underneath there are issues that could cut down some specific stocks in their stride.
One of the major problems is over capacity. Corporate America invested hugely in technology during the second half of the 1990s until it reached its peak at the height of the dot.com fever in 2000. However, cracks began to appear and it became apparent high investment levels were not sustainable. The bubble burst and the rest, as they say, is history.
The sudden downturn has left companies with excessive inventory levels. This over- capacity is in turn leading companies to reduce their IT expenditure. A recent survey of 100 of the top 1,000 American companies by Goldman Sachs indicated that many large companies were continuing to rein in IT spending.
However, the easing of fiscal and monetary policies is certainly helping the US economy to get back on track. The US Fed has been unprecedented with its interest rate policy and in a bid to stave off a recession it cut rates aggressively last year. We are confident that Greenspan's actions have set the US economy on the road to recovery.
When there is a recovery, it will be those those companies that have built up low inventory levels through lack of demand that will benefit first as any pick-up in demand will feed straight through to increased sales. However, we are concerned with the over-supply in the long-distance telecom arena, where demand is unlikely to pick up for at least 18 months.
Recent announcements from France Telecom and Deutsche Telekom did little to change our opinion. The German telecoms giant was forced to slash its dividend by 40% admitting it would take longer than planned to cut its debt.
Many semiconductor stocks such as Intel and Applied Materials have enjoyed a good run and their share prices have risen sharply. However, valuations look high and some investors may have jumped the gun ' we think that any pick up in demand going forward is now already priced in.
While companies such as Intel have inventory issues, software companies such as Microsoft and e-business software company and Microsoft Siebel Systems do not.
Microsoft is a company that is difficult to ignore and is our biggest weighting in the Jupiter Global Technology Fund. The key in the software sector is to pick strong, dominant companies that have plenty of cash on their balance sheets.
There are also opportunities in the service sector. Names that crop up include Affiliated Computer Services and the IT consultancy, Accenture. Electronicical manufacturers such as Celestica, that supply the likes of Cisco Systems and Sun Microsystems, are also well positioned for a recovery.
Although within the portfolio we have cut back our telecom exposure, the stocks we do favour include Nokia and Vodafone. Nokia may have recently reported a sharp sales fall in its network division, but it is the world's largest mobile phone company and its handset business is still doing very well.
We are still overweight in the Israeli internet security company Checkpoint, a stock we have held for some time now. It is one of the world's most profitable internet companies and we reckon there is more growth to come from its area of the market. Companies such as EMC, which sells large data storage systems, also present opportunities.
The storage area of the market will be strong because the amount of e-mails people are getting is booming and it is not just text these days that needs storing, it is also video.
Another company that has caught our eye is Ciena, one of the world's biggest optical equipment makers that should be a survivor. However, the media sector also offers some attractive opportunities and they include Viacom, which owns Blockbuster Video, the Paramount Channel and MTV. Despite being hit by the downturn in advertising spend, the company recently hinted that ad spending could start to pick up again.
The volatility of the past two years has helped separate the wheat from the chaff and many poor quality companies have been thrown by the wayside. Dot.com mania is firmly in the past. The fund no longer owns the likes of Yahoo and eBay, on the basis of their valuations. because we do not think they have good business models going forward. Many stocks that have plunged to new depths will probably never recover to their previous high levels.
Hard evidence is needed to show that demand is actually picking up before we start to get in a bullish mood again. Yet, there is hope. Only a month ago a study by IDC, a market research company, said demand for PCs is set to rise 3% this year and 10.9% next year because of strong Asian demand and unexpected robust US retail sales.
We believe those companies that will initially benefit from an increase in demand will be the large and medium-sized companies. We have recently cut our small cap weighting, which used to account for about a quarter of the portfolio, it is now just 10%.
Better news for investors is that valuations are not as high as they were and they are more realistic. Go back to 1999 and analysts were forecasting 50% on a P/E of 80, that is no longer the case. However, valuations vary depending on a country-by-country basis.
The valuations are more reasonable in the US than elsewhere, while there is a lack of choice in Europe. In the UK, for instance, there are just a handful of technology stocks in the FTSE 100, the most notable being Sage and Logica. On the Continent, valuations are more expensive. For example, the Germany-based SAP, Europe's largest software company, trades on a P/E of 55, but you can find similar companies in the US which will trade on a P/Es of 25 to 35.
The worst scenario for the technology sector, and for any other sector for that matter, is a double dip recession in the US. The US is still the main driver for technology stocks, two-thirds of the technology fund is invested in the US.
However, we do not think a recession is likely and the lead indicators coming from the other side of the Atlantic suggest recovery is on its way. The latest consumer spending figures may have been lower than forecast, but they are still up and any move in an upward direction has to be good news. If GDP forecasts are raised, then share prices will rise in anticipation of a pick up in demand.
Obviously no investor can rule out another external event such as a terrorist attack or further major air strikes. The frailty of stock markets was in evidence last month when warnings from the FBI about on another terrorist attacks led to immediate jitters on Wall Street as investors rushed to lock in any gains they had made.
However, such threats are not going to go away and it is a question of building such factors into your outlook. In the short-term the outlook is less than clear, but the long-term technology story is still intact. A global economic recovery will result in increased productivity and greater investment in technology companies. There are plenty of technology, media and telecoms companies out there that will be able to generate earnings in excess of both GDP growth and the market average.
The events of 11 September compounded the problems the tech sector was already experiencing.
The Nasdaq has gained 30% from its 52-week low last September.
The key to the software sector is to pick strong, dominant companies that have plenty of cash on their balance sheets.
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