THE QUARTERLY MARKET SECTORS TO WATCH

The Fourth Quarter of 2000 Commentary - by L.K.S.* October 25th. 2000

Investing and other branches of Economics are much an Art as Science. After the Charts, graphs and other quantitative methods, the social half of Economics - The Human Behavior factor - generally has the final say! This bull market, although long and exciting, will not last forever. As such, an informed investor will be positioned better to withstand the coming economic downturn with the least exposure to losses. If you are a first time visitor to this column, we advice you to visit our archives section (link is below) to get a proper understanding of our methods.

INTRODUCTION

Our forecast for Q4 will generally mirror the Q3 forecast. This is because our Q3 forecast is still blooming due to the recent drop in the stock market and the Federal Reserve's FOMC policy uncertainty. The rise in oil prices, the performance of Amazon in fiscal Q3 has caused us to revise some sectors of our forecast. Most economies and companies delayed their activities as stock market devaluations and increasing borrowing costs made it almost impossible to survive, let alone expand. We have have a new outlook on Online Retailers, Networking and Non-PC chip makers, Europe and the Euro, and Africa & Middle East OPEC members.

UNITED STATES AND CANADA

CONTRACT ELECTRONICS MANUFACTURERS

It use to be that everyone who had something to do with electronics manufacturing was an Original Equipment Manufacturer (OEM), or an Asian outpost. Not anymore! North American and European Contract Equipment Manufacturers (CEMs) like Flextronics International, Jabil Circuits, Celestica, Solectron, Celestica, Plexus, Manufacturer's Services, and Benchmark Electronics are increasingly becoming the players to contend with. Recent multi-billion dollar outsourcing contract deals, offshore facilities acquisitions and expansions, and the unprecedented large market capitalization are all boosting this once ignored sector. As more OEMs dispose of their manufacturing units and turn more to outsourcing with CEMs, the more valuable CEMs are becoming, especially those with offshore satellite operations. The only notable concerns have been that the CEMs have a narrow customer base and the market can get quickly crowded. The CEMs are countering these fears with long-term and very broad contract agreements with their customers (just like Lexmark International did when they acquired IBM's printer business). Secondly, as CEMs lock in deals with their customers and aggressively acquire former OEMs, an artificial barrier to entry develops in the sector, thus allowing these few players the chance to dominate the market.  We appreciate your feedback on this subject at our Discussion Forum.

ONLINE BROKERAGES AT THE BAT!

North American online brokerage stocks have taken a beating lately, and who hasn't. However, beyond that general market torture, this is a sector ripe for good rewards and do have a very bright future ahead of it. Companies like E*Trade Group, Charles Schwab, National Discount Brokers (NDB), etc. were closely watched to see if they can pull it off, and they have! The crash and burn of the Dot Coms haven't affected them, nor has long-term revenue fears. What is now left is to carry this North American experiment globally and allow even villagers in say, Africa or Latin America armed with a cell Phone to play the global financial markets. That, is the grand vision and reward, which most in the sector are already close to.

ONLINE RETAILERS, DELIVERY COMPANIES AND CHRISTMAS

The spectacular performance of Amazon in fiscal Q3 has made us readjust our outlook - we are still cautious about online retailers still. Why Amazon reported stellar earnings and customer base increases, the fundamental fears about online retailers remain: Can they Handle the Christmas season mad rush. Secondly, have their customer management style improved from the previous year? We actually think very little has changed. The recent downturn in the stock market not only made it harder for online retailers to raise capital in the stock markets, but venture capital and other funding companies have shrunk from the idea of giving these companies more many. What does this all mean? To improve your on time delivery system and do real person customer support, you need money, lots of money, and we haven't seen most of these companies succeeding even in that. Other companies have decided to add more merchandize or services they offer in hopes of propping up their stocks temporary. The problem with the temporary prop up is, these companies will have to learn the delivery services part of that market in the Christmas season, and make mistakes that are common for first time players. The only problems: Investors are not interested in waiting for retail learning curves again! We ran an experiment by ordering 3 items for 3 major online retailers and wanted to see how their customer, shipping and return policy looked like going into the year 2000 Christmas season. One of the Merchant had an excellent return and replacement policy. The second had a good return policy, but our credit card ended up being billed by one of their subsidiaries for services we never ordered. The Third one refused to take the merchandise back because we had it over 30 days: Never mind the fact that they started counting the 30 on the day we placed the order, and it took them 15 days to deliver the merchandize. All said and done, we are going to pass on retail stocks. We do however, recommend delivery companies like FedEx and UPS.

BUSINESS TO BUSINESS (B2B) REVISITED

Despite a Prudential Securities' downgrading of the major Business to Business (B2B) companies, and the seismic shockwave that went through the sector, we are still bullish on the sector. B2B retailing is really the natural progression step for the web and major corporations, especially since a good track record can be found in Electronic Data Interchange (EDI). B2B powerhouses like Ariba, CommerceOne, and i2 Technologies have signed and gone into co-development agreements with major industrial concerns like Ford Motor Co., General Motors, DaimlerChrysler, Toyota, etc. who spend literally tens of billions of Dollars a year on supplies, procurement, and are major EDI users. These industrial giants are quickly becoming the partners to these B2B ventures. Secondly, the eMarketplaces B2B companies provide will save billions of dollars to companies who take advantage of it. To ignore these B2B leviathans  in the short run will be rather expensive in the long run. As always, your views are welcomed at BusinessJeeves.Com Discussion Forum 

FIBER OPTICS AND NETWORKING EQUIPMENT MAKERS

 Fiber Optics, Networking and chip making stocks have come under hit lately, due primarily to (at least aggravated by) the performance, or lack of performance, for Nortel Networks in revenues growth for fiscal Q3. We still see very strong prospects for these stocks (excluding PC chip makers). While Nortel Networks' revenues were below what Wall Street expected, we shouldn't over-react on the sectors. These companies are in frontier businesses that frankly no one can exactly forecast their future growth rate correctly - don't get confused, the sectors will grow strongly, but can we quantify the growth rates correctly? Not really. For an example: Nortel Networks have been blowing out earnings estimates for every quarter (including the infamous Q3). As the web expands and more devices are used to access the web, not only are non-PC chip makers going to keep growing, but networking equipment makers will see the demand for their services keep growing as outdated networks are replaced with those that can handle data, voice, media etc. at the same time and faster. That is where these companies are going to make a killing. If we base these companies stock valuations on their P/Es, you probably would have ignored a Ford Motor Company stock when Cars and Mules shared the road: There were stalls everywhere for the horses and a very good and long standing profitability record too. But look at Ford, or any automobile maker now. Needless to say, we are still bullish for these sectors. 

BIOTECHNOLOGY REVISITED

Recent comments from US President Bill Clinton and British Prime Minister Tony Blair about open access to biotechnology research work caused a free fall in the sector, and it hasn't recovered fully since. We actually see some good in this pronouncements. This will give the sector the opportunity to tap more gifted minds out there so as to increase the level of discovery. Sharing research work doesn't mean you will loose your patent, or some scientist will set up his own genome lab and wipe all biotechnology companies out. We see the contrary. BioScience requires extensive (and costly) research, then the tedious efforts to get published for peer review. The Biotechnology companies have the funds, the facilities, and the experienced staff to attract new talent, as opposed to loosing it. Recent discoveries and new treatment advances also make this sector hard to ignore simply because two politicians voiced their opinions on something that they seem to have little control of. Even if they do have the control, it might takes years to implement. We see industry leaders like Amgen, Ariad Pharmaceuticals, Genome Therapy, Ocular Biosciences, Trega Biosciences, ISIS Pharmaceuticals, etc. having a stellar year.

EUROPE

Our forecast for Europe will be more or less the same as last quarter's. European economies will perform strongly up to 2001. We are most especially optimistic about the Telecommunications, cable and wireless and financial services sectors. The key players in telecommunications will be the German, French, British, Italian and Spanish "National" telecommunications companies. We expect the Northern European players like Ericsson and Nokia to lead the way in new exciting hand-held internet access technologies. This is the year that Europe will be like 1998 Internet industry in the U.S.A. We are expecting a reasonable amount of web use increase, and the public offering of such companies. Perhaps, the surprising underdogs will be Spanish Internet ventures, as they move aggressively to meet the growing demand for Spanish web portals and content around the world.

EUROPEAN CURRENCY WOES

The continuing weakness of the European single currency, the Euro, is of concern. While the weak euro is good for European exporters, it becomes a double-edged sword because it influences economic slowdown around the world, and other countries resist the idea of joining the single currency regime - thus stopping the single currency from being what, theoretically, it could be. Another downside to a weak Euro is the failure of European countries to import cutting edge technology that could improve productivity in the long run. Recent semiconductor billings data shows that Asia (excluding Japan) places orders for networking and semiconductor related equipment than Europe - and these are the backbone of the future economy.

We expect European Investment Banking concerns to acquire more US Investment banks.  

ASIA

Asia, (including Japan) is actually going to do quite well. Regional powerhouses like Japan, South Korea, Singapore, Hong Kong, Taiwan, and Malaysia will lead the pack Telecommunications, Banking, Technology (especially Software & manufacturers) will do quite well.

Nippon Telephone & Telegraph will do very well as the world moves into handheld devices to access the web. Over the years, this company's cellular & wireless unit have been hard at work building a sophisticated network in Japan that is the model for the world. We expect this wireless unit to be spun off, and to expand its operations to other parts of Asia. Singaporean, Malaysian, and Hong Kong telecommunications companies are not sitting by and watching "DoCoMo" have all the fun either. Recent hostile moves between Singapore and Hong Kong telecoms are just the signs of things to come-acquisitions and mergers across boundaries.

India's software industry has had a spectacular run in the past few years, and we expect more to come. Companies like Amdahl, Infosys Technologies, and Satyam have opened the door for many Indian software companies to tap the rich North American capital markets.

Technology components manufacturers in the region are going to enjoy a very strong year. Cellular and wireless handheld device manufacturers, memory chip manufacturers are just a few in this category that will enjoy a boom as the Internet and flexible access demand around the world continue to increase.  

LATIN AMERICA

South American Deposit Receipts (ADRs) have been gaining on U.S. exchanges lately. We expect tremendous growth in the Telecommunications sector. South American telecommunications companies stand to dominate in the "New Economy" as the Internet evolves in South America. Unlike in the U.S. where the Internet and e-commerce developed independent of major telecommunications companies, these South American companies stand to use both the North American and European models (and they have) to position themselves as the major and most potent players in the region. These companies will become some of the most prized companies in months to come. Argentina, Brazil, Chile, and Mexico will be the stars for the region.  Mexico's energy sector will also enjoy a robust growth. 

Venezuela has what it takes, but the recent natural disasters will take up resources that would have otherwise been used to improve its infrastructures. Nevertheless, Venezuelan energy and telecommunications companies will perform better than any other sectors of the economy. 

As commodities prices continue to be depressed, most Latin American countries will not do well. The only exception to the rule here will be the oil producing countries of Mexico and Venezuela. Argentina and Brazil will be least affected because they produce multiple commodities, and least dependent on commodities exports as the only source of foreign exchange.

AFRICA AND MIDDLE EAST

The outlook for Africa and the Middle East just got fuzzy as violence in the Middle East stands the chance of spreading to other parts of the world with sizable Islamic and to some degree Jewish populations. How is this bad? Oil prices above $30 a barrel is bad for both producers and consumers. High prices causes the consumers to find alternate sources of oil and energy. When you include uncertainty - like the violence in the Middle East, the search for alternate sources actually speeds up, and that is bad for OPEC producers in the longrun.

The commodities market has been hard hit lately. Unfortunately, the US Midwest drought will not benefit Sub-Saharan African producers, due to the difference in commodities affected. Apart from the Oil producing economies like Nigeria, Gabon, and Cameroon, the only other economies that stand to do well are South Africa, Botswana, Namibia, and Zimbabwe. South African software firms are making a good stride on the global scene. However, mining will continue to dominate the South African economy for a while. A note of Caution about South Africa: The high unemployment rate is something of a grave concern, especially in a country that is politically very unstable, and South Africa has the makings of a pressure cooker.

Israel has what it takes to do very well in the next few years. Expect technology, telecommunications, Software and Internet companies from Israel to become major players in the world.

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* Mr. L.K.S. (he requested anonymity) has a graduate degree in Economics from a highly respected Public University in Virginia, U.S.A. For the past Five years, he has held many posts. Notably: State Economist, Economic Consultant, and Research Economist for a Large Mid-western University. He now lives in California.

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