Focus on large caps (page 1 of 3)

US Stocks

When the Federal Reserve Bank first initiated its tightening policy back in June 1999, the S&P500 Index, despite correcting in the subsequent increases, managed to hit a high in March '00, shortly before the Fed's sixth and last increase of 50 basis points. There was even an attempt to retest the high in August before the S&P500 finally succumbed to the earnings decline and the eventual correction ensured.

From an earnings perspective, growth did not peak till the second quarter of 2000, and perhaps that is why the market index continued to power forward during the early stage of the Fed tightening. In a sort of reversed mirror image, the S&P500 rallied and went down again as the Fed first reduced the Fed Fund rate by 50bp. It may continue to remain weak as the index had remained strong during the early stage. The key here is for the Fed to keep on lowering interest rates so that the earnings decline would bottom and reverse itself.

The market has corrected from its extreme valuation, and current levels are closer to fair value. The potential for a spending retrenchment is a greater threat; an economy must have increasing consumption to support higher earnings if higher equity prices are to be justified and sustainable. Although the stock market is no longer at an overvalued extreme, but there are still earnings worries. If growth remains weak, real earnings growth will need a year or more to recuperate.

Rate cuts of over 100 basis points as implied by the credit market will certainly have a positive effect on the equity markets. And the monetary environment has just begun to turn easy. Now is the time to position the investments for an improvement in earnings in the next 6 to 9 months.

The initial focus should be on the large caps (see table below); some of these stocks are at attractive valuations. Then the beaten down quality tech stocks should be considered on a selective basis.

US Technology Stocks

In the year 2000, the NASDAQ Composite Index posted a crashing performance of -39.3%. The Internet "dot.com" bubble imploded, and optimistic profit exuberance degenerated into free-fall panic. Investors have over-reacted to concerns of earning decline. We believe the scenario of a bottomless pit to declining stock prices is but a shadowy dream. Why? Because, the growth engine of the Internet continues to roar. As the "hunger" for information is insatiable, the Internet will remain the mainstay communication vehicle.

Demand for Internet access continues to grow, as evidenced by AOL's recently announced growth in subscribers. In less than 49 days, AOL added one million subscribers in November (at nearly the same rate as in October) and now has more than 26 million AOL-branded users.

With the Internet adoption rate increasing, the demand for access speed will continue to grow and subsequently, attract more Internet-related (software and hardware) applications and utility resources. Demand is currently pent up and access is constrained. While the broadband infrastructure buildout will continue, the focus for the year ahead will be maximising efficiencies over the existing backbone network (to derive more value from every dollar invested).

While investors are struggling to understand the new virtual economy game, the lessons derived from 2000, which should aid us in 2001, points to 2 traditional success philosophies; (a) strategy and (b) focus.

What is our strategy? Are we to fully invest funds into technology or do we apprehend risk by diversifying our sector exposure?

What is our investment time horizon? Do we pile up our capital into a 1 week investment return scenario, or do we spread out our investments into multiple time horizons?

What is our expected return? Shall we look forward to an indefinite return or shall we peg a large portion of our capital gains to a predefined amount?

While we prepare happily for up days where accelerated rising prices promise the rewards of jubilant wealth, have we set aside contingency plans for a contradictory outcome?

Is our strategy overly aggressive or excessively conservative? Have we recognised the inherent price volatility and will our hearts be at peace with the decisions?

While stock prices soar towards the sky or plunge deep into the abyss, are we still focused on our investment strategy? .

Do we scramble to buy stocks on up days (sell vehemently on weak days) or do we remain focused on selected top tier stocks?

While there is no added value in crying over spilt milk, rich rewards are in store for those who learn from past follies.

We maintain that the 1H01 will be plagued with high volatility, which could present many profitable opportunities or many hidden poverty traps.