The summer’s sell-off in the hi-tech market has continued into the autumn across Europe, and shows little sign of abating. The sector has also been hit by profit warnings,especially in the US market, which rather than heralding a hard landing for the economy there, reflects instead the high profit expectations in this sector.
Two major influences have underpinned market belief in the past few months, says Philip Isherwood at Dresdner KB. “First of all there has been a strong feeling in favour of a soft landing
for economies worldwide, and this was perhaps best exemplified by the Fed’s decision to leave interest rates alone. Then, however, oil price hikes indicated a
slowdown and had an impact on profits.”
James Barty at Deutsche expects a continued de-rating of the technology sector. “In Europe we are seeing suppliers being hit by the performance of their clients, and we anticipate a continued correction in the technology sector.” He points out, however, that it has not all been bad news. “The Nokia results were better than expected, but again the feeling is that it is difficult at the moment to predict how some of these companies are really performing, and hard to pin down actual expectation.” He feels that by a process of default defensive stocks and non-cyclicals have benefited. “That is where the money
has been heading, for no other reason but that there has been a big sell-off and these stocks are looking cheaper, and safer.”
Nevertheless, traditional safe havens such as financials have been a mixed bag. Although some insurance stocks have done well and benefited, a number of investment banks have been hit. “There is a feeling that there may be some bad news hidden away, as some of the banks have been heavily involved in sectors which have been part of the re-rating,” says Barty.
He suspects the market will continue to be volatile for a couple of months. ”There is no real sign of a general weakening around the world in a macro economic sense, but equities are clearly struggling. This is a result of
the profit warnings, and
the effect of the oil price
crisis which has squeezed industrials and other cyclicals,” says Barty.
Delays in floatations and acquisitions due to the volatility of the market are continuing to hit TMT stocks across Europe, but as Barty points out defensive stocks are benefiting including, perhaps surprisingly utilities.
Although Isherwood agrees on defensives, he suspects that the market will begin to discriminate a little more over the next few months. “Although I would expect defensive stocks to continue to outperform, I think we may see a return to the classic way of playing them. This means that although food and drink, pharmaceuticals and utilities will do well, investors will begin to look to buy profit growth too.” Isherwood warns that a more selective view will not only be limited to those stocks, but will also apply to TMT stocks. “Expect a return to some of these stocks, but not on a sector-wide basis. Investors will look for better performing stock, with a solid business profile,” he says.
This could lead to a re-rating of parts of the TMT sector, which Isherwood feels is overdue. “There is no real surprise to the market shape, which is virtually the inverse of what it was 12 months ago. Some small shifts are having a significant affect. However, the market is coming to realise that the technology sector is showing cyclical characteristics. It may come as a surprise to many that the new economy is cyclical too.”
He suggests that at the moment there are “few places to hide” but asserts that though there is still more of the shake out to come, it is likely to be more selective than over the summer.
The cyclical nature of the technology sector is also touched on by Mike Young senior European equity strategist at Goldman Sachs. “There is a growing realisation that earnings in tech stocks are more sensitive to economic growth than most anticipated. This is not news, however, as it was recognised a long time ago. What we are seeing is a group of new analysts and investors who have either forgotten this or never learnt it,” he says.
Young feels that the markets have been pricing in the increased uncertainty over next years earnings. “Even if we see the predicted growth across the Euro-zone of around 3% on GDP and inflation just over 2% calls of 14% on earnings is still too high. We suggest a figure of around 8% will be more realistic. Even so, when the cut in expected earnings is announced next spring, we cannot see the markets making much headway.”
He also warns that inflation may be rising faster than anticipated, and again warns against assuming the new economy will off-set that. “The problems of rising oil prices and a weak euro are not likely to be overcome by the performance of new technology. Having seen that argument used in the US we are seeing inflation there also on an upward curve.” The reaction of the ECB will also be monitored closely, and Young suspects they may
well react “more strongly” than they have in the past to such pressures.
The bond markets have not really reacted to such worries so far, but there are signs that investors may return there if we do see rising interest rates, and this will inevitably be bad news for equities. “All in all we are likely to see a flat
start to the New Year, or at worst a depressed market,” says Young.