Fund manager's comment/Alan Porter
Between the start of this year and the end of August, the European equity market lost almost a fifth of its value, as measured by the MSCI Europe ex-UK Index.
This represents the largest eight-month fall in more than a decade and a significant proportion of this decline has been accounted for by the technology, media and telecoms (TMT) sector ' which has lost about 45% of its value over the same period.
The synchronous global economic downturn has resulted in a sharp fall in export demand, ending the boom in corporate investment that was partly fuelled by capital expenditure on technology infrastructure.
Given that share price growth is driven by earnings growth, then it should have come as no surprise that technology stocks came under such severe pressure, given their failure to match the overly optimistic growth expectations placed on them. Such over-inflated expectations were more to do with hype than reality, although that is not to say that there were not some high-quality companies in this area of the market that found themselves trading on low ratings. Having fallen so far, the TMT sector is now discounting a severe recession and it is for this reason that we have recently increased our overweight position.
Our stance is rather more bullish than our peer group, as we believe that such an economic outcome is unlikely and that the absence of such a severe recession is likely to see the sector leading the market rally. Set against this, if the economy does take a turn for the worse, the fact that this scenario is already priced into the sector ' more so than in other areas of the market ' is likely to mean those areas emulating the fate of their technology counterparts.
Relative to future earnings expectations, many companies in the technology sector are trading close to historic low valuations. Our favoured technology stocks include Phillips, Alcatel, Infineon and Cap Gemini, while within the telecoms sector, we believe the best prospects lie within service providers, such as Bouygues and Telefonica.
Our key underweight positions are in pharmaceuticals, which are trading on historic peak multiples; energy, which is coming under pressure from concerns over the falling oil price and the lack of production growth; and industrials and materials, which have recently enjoyed a strong rally.
Falls of the magnitude seen so far this year are not unknown in the European market, although it is worth noting that such setbacks are often followed by sharp rebounds.
While it is difficult to predict exactly when the market will bottom out, there is a high likelihood that the market will recover strongly over a fairly short period of time. We expect those technology stocks that have been hit hard recently to be at the forefront of this recovery.
Alan Porter is a European fund manager at Old Mutual Asset Managers
• Strong recovery to follow weakness.
• Corporate investment and exports slowing.
• Techs trading at historic low.
• Equities pressured by economic weakness.
• Rcession may not be discounted.
• Pharmaceuticals trading at peak.
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