The recent correction in technology stocks has had a significant impact on the US smaller companies ...
The recent correction in technology stocks has had a significant impact on the US smaller companies sector due to their high weighting in this part of the market.
Technology, media and telecom stocks did so well over the last year that they have grown to 50% of the US smaller companies index, according to Graeme Glen, Foreign & Colonial's US Smaller Companies Investment Trust manager. This has led to vulnerability in the index as tech stocks go through a period of such volatility that analysis has become futile, he believes.
"Demand in the sector has been so strong over recent years that tech stocks have not followed cyclical patterns," he says. "Analysis is difficult because so many stocks are overpriced and there is a lot of bloodletting going on during the volatility. You have this huge beast called the technology sector whose behaviour has nothing to do with macroeconomics or whether Alan Greenspan wants to raise interest rates."
Jim McCabe, divisional director on American Equities for Capel Cure Sharp, agrees technology is a major destination for investors' money. However, while strong growth across the sector has thrown cyclical models out of kilter there are still ways to pick out stocks which will survive.
McCabe says: "You don't just look at a company's growth but how fast the growth is accelerating. If you can see it will turn revenue growth into bottom-line earnings in under three years, it may be worth pursuing."
McCabe feels there is plenty more life in the sector as firms like Ford realise they must develop e-commerce models. "The well-placed smaller caps are going to be big winners as old economy firms seek their advice," he adds.
Companies like internet strategists Sapient, which joined the S&P500 on 5 May, Commerce One and business to business specialists Ariba should benefit as the demand for consultancy grows. Foreign & Colonial is bearish on tech stocks in the small cap sector, believing they are vastly overvalued. This is a stance the firm has held for five years and despite missing out on the phenomenal surge of the tech sector in 1999, the portfolio will remain underweight in the sector for the foreseeable future.
Glen says: "Unfortunately we were wrong about the tech sector before. However, we have been up about 5% in the last two months while tech funds have lost on average 20-30% and other smaller company funds are down about 12%."
Glen's portfolio holds lot of service industries and media stocks, but emphasises these are very much stock specific plays. He favours businesses which are relatively non-cyclical with high operating liquidity and low capitalisation.
Companies like Lamar Advertising, CH Robinson and Infinity Broadcasting have a strong controlling position in their respective markets, which endows them with price flexibility. For example, the US has a fixed number of billboard sites. Lamar Advertising has been acquiring rival companies over the past two decades and is in a dominant position, he says.
McCabe feels the market will continue its volatile pattern but bottom out soon. Meanwhile Glen feels volatility will continue as US interest rates rise.
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