The US is experiencing its longest economic growth
period in history. The end of February marked the
107th month of strong economic performance,
surpassing its previous record set in the colorful 60s (106
months between 1961 and 1969). A bull run on US equities

• with the occasional hiccup – has kept in stride with
  growth. Over the last five years, the Dow Jones Industrial
  Average (DJIA) rose 197%, S&P 500 climbed 219%, and
  the Nasdaq composite index soared 907%.

Rejoice, celebrate, open a bottle of champagne? That’s not
what is happening on Wall Street. The Federal Reserve,
headed by chairman Alan Greenspan, is worried that the
American dream is on the verge of overheating (average
GDP growth rate over the last three years was 4.8%), with
the threat of inflation just around the corner. Since June last
year, the FED has raised the federal funds rate by a quarter
percentage point four times (three times for the discount
rate). Its objectives are clear: To keep inflation from getting
out of hand, the FED wants to strike first by curbing robust
consumption, slowing down the economy.

A slew of indicators show that there’s potential for overheating.
Greenspan is keeping his eye on the tight labor market.
In January non-farm payrolls increased more than
expected – by 387,000 – the largest jump in two years. That
pushed unemployment down from 4.1% to 4%, the lowest
level in 30 years. This could lead to wage and compensation
increases that would pass on to prices covering costs,
and there are signs that upward pressure on prices might
come soon. In the fourth quarter of 1999, the employment
cost index (wages, salaries and benefits) rose 1.1%, above
the expected 0.8% increase, followed
by a wage increase of
$.06 per hour in January.

Another concern for
Greenspan is the stock market
pumping money into consumers’
pockets which lifts consumer
spending. In 1989, 28% of
household financial assets were
linked to stocks. That now
stands at 54%, and Greenspan
believes that about a quarter of
the GDP growth rate is derived
from wealth coming from stock
gains. This gives Greenspan a two-pronged attack: slow
down the economy and/or get the
stock market to take a breather.

Greenspan’s intention of controlling inflation has sent
shimmers through some markets. So far this year, the DJIA
fell more than 11%. And to make matters worse, hikes in interest
rates are expected to continue this year. “The chances are
high,” says Douglas Wilde, a global investment strategist at
Merrill Lynch. “We will probably see interest rates go up
between 50 to 75 basis points by the end of the year.”

If this is the case, should investors expect the markets to
respond negatively, fueling a correction, or something
even worse? According to Gary Shilling, president of A.
Gary Shilling & Co, economic consultants and investment
advisers, there will be a correction or even a crash coming
from the sting of rising interest rates. But it appears that
there have been two markets going on recently. While
many stocks have already been hit, technology stocks
have been immune; they have pushed Nasdaq up over 8%
so far this year. Shilling believes that technology stocks,
which are seen as extremely overvalued (many companies
trade more than 100 times projected earnings in 2000, if they
have any), will eventually be affected with the rest of the
stocks and prices will plummet.

Wilde, on the other hand, believes Greenspan will be cautious,
moving rates no more than a quarter point each
time, knowing that markets are sensitive to his actions. The
chairman has a history of taming economic growth with a
soft landing. And some figures are working against the indicators
that are screaming danger. In the third quarter of 1999,
the consumer price index climbed 4.2%. But in the fourth
quarter, it increased by 2.2%, followed
by a less-than-expected
0.2% rise in January.

But Greenspan still appears to be
on the hunt. In his last semiannual
economic presentation to
Congress in mid-February, he
made it very clear that he would
continue raising interest rates
until consumer spending retreats
and the stock market calms
down. Tightening the screws is a
sure bet. But if and when it hits the
breaking point, sending all stocks
south, is anybody’s guess.

Global economic optimism may have lost its upward
momentum according to our February Fund Manager Survey.
The inversion in the US yield curve could be taken as a sign
that Fed rate hikes are biting and the US economy is slowing.
If this were so, it could be time to cut cash and go overweight
bonds. A peak in the global manufacturing cycle would once
more align structural and cyclical forces in favor of disinflation.

Two risks keep us on the sidelines. First, the oil price could be
allowed to spike higher if OPEC think a high oil price poses no
threat to the global “e-conomy”. Fund managers do not expect
the oil price to stay at $30, but our global oils team are warning
of $45 if production is not increased. Secondly, and more
fundamentally, there is little evidence that the US economy is
slowing beyond the technical rally in bonds. Most fund managers
think the peak in Fed Funds is a couple of hikes away. We
are not so sure. We remain overweight cash in our UK benchmarked
global mixed fund.

Growth at any price?

We have used our Global Sector “Wheel of Fortune”
model to explain the fund manager love affair with TMT
(Tech, Media and Telecoms). These stocks are the New Era’s
cyclicals, or Growth Cyclicals. Cross-checking fund manager
preferences for Growth stocks with their preferences for
Cyclicals seems to bear us out. Japanese fund managers are most taken with TMT whereas US managers are the only ones
leaning towards Growth Defensives such as Pharmaceuticals.

Growth investors could be caught out in 2000 if the global
economy stays strong and commodity prices surge as they did
in 1994. When pricing power becomes widespread, investors
refuse to pay a large premium for long-term growth. Value
stocks tend to outperform by a wide margin.

When to switch back into the UK?

The UK equity market has underperformed Europe significantly
in the last couple of months. UK earnings
forecasts have not been downgraded. UK equities have been
de-rated by around 25% relative to Europe to reflect the fact
that fund managers expect the UK to slow while they expect
Europe to remain strong.

This period of UK underperformance could end in one of two
ways. UK economic optimism could recover as fund managers
factor in a peak in base rates and a soft landing in the economy.
Or European economic optimism could fall as the Eurozone
economy responds to more aggressive ECB rate hikes.

We expect a UK soft landing to precede any European slowdown.
But judging by Eddie George’s hawkish tone it could
still be a little early to switch back into the UK. There may be
one or two rate hikes left.

European Sector Strategy

• Extremes exist within the European equity market,
even to a greater extent than on a global basis.

• The TMT (Technology/Media/Telecoms) sector
generally has poor value, but newsflow and sentiment
are driving the sector higher.

• Differentiate within TMT – overweight IT Hardware/
Electronics, underweight Media.

• Hedge selected TMT with some value –
overweight Oils & Banks.

Extremes clearly exist within the European equity market,
where valuations are becoming somewhat meaningless.
Fear of underperforming benchmarks in the
institutional world at a time when consolidation is causing
some weighting nightmares, combined with a rush of liquidity
from the retail market into a relatively scarce space are just some
of the factors encouraging these extreme sector divergences. We
are painfully aware that trying to predict the “bursting of the bubble”
is difficult, and in any case, these sector divergences could
continue for longer than anyone anticipates.

The divergences between sector performances and valuations
are even more extreme in Europe than in the US. European TMT
trades on over 60x 2000 forecasted earnings (I/B/E/S), compared
to the US TMT constituents of the S&P, which trade in aggregate
on just over 40x, yet both groups have similar growth prospects.
And whilst 29% of the US TMT stocks have actually declined over
the past three months, this has only occurred to 12% of European
TMT stocks.

The driving forces of these extreme positions are partly global,
partly European, and are illustrated below.

• The long-term growth of the market is estimated by analysts
to be 10%, while the long-term growth rates for the IT Hardware,
Software, Media and Telecoms sector are 26%, 21%,
12% and 15% respectively and are on a rising trend.

• Penetration rates in Europe are much lower than those in the
US allowing room for catch-up.

• Consolidation is still driving the TMT sector. 1999 saw
record M&A activity where 32% of all global M&A
involved a European target, up from 23% in 1998. And this
year has started well, with the Vodafone/Mannesmann deal
beating all global M&A records. Of the top 50 M&A deals in
1999 involving a European company, 42% (by value)
involved a TMT company, up from only 3% in 1998.

• According to our Gallup survey of fund managers, Technology/
Media/Electronics and Telecoms are the four most
favored sectors in Europe and this has been the case since
April 1999 when pharmaceuticals dropped from its high
perch. And not only do they remain favored sectors, but over
the past three months, fund managers have actually
increased their preference for each of these four sectors.
Research in the UK shows that the Gallup survey is best used
as a confirming indicator rather than a contrarian indicator
on a sector basis.

• Although we don’t have ownership details yet for Pan
Europe, UK fund managers are currently only 94% weighted
in TMT and post the Vodafone/Mannesmann merger this
is likely to fall to 86%.

• News stories abound fuelling investor sentiment. Screening
Reuters and the Financial Times for stories involving companies
announcing an “Internet strategy”, there have already been
160 stories so far this year (an annualized rate of 1840) compared
to 324 for the whole of 1999 and merely 27 during 1998.

• Liquidity is pouring into the markets. Borrowing in the US
to buy securities rose at an annualized rate of over 400% over
the past quarter, which accounted for 25% of the growth in
total US bank lending. In addition, according to Trim Tabs,
US margin debt as a percentage of market cap has now
exceeded the September 1987 previous record of 1.38%.

These are signs of excess in financial markets. Although similar
comparable data is not available for Europe, we also know
that European mutual funds saw inflows into equity funds in
Q4 1999 of $40 billion – a record quarterly inflow.

• Scarcity of tech stocks is a relevant factor for European
investors. Although TMT now accounts for 32% of European
market cap (up from 18% 12 months ago), this still lags the
US where the TMT weighting is 42%. The European/US
divergence is clearly much greater in the Internet space
alone, where the European Internet sector’s market cap is
around $140 billion (up from only $17 billion at end September)
compared to close to $1 trillion in the US.

We compared European sectors with their US and Japanese counterparts
in the February Sector Strategy and they were some of the
most staggering set of charts we’ve ever run, very clearly illustrating
the extremes within sector rotation on a global scale.

Our main message is the need to differentiate within the
TMT group. It is clearly not ideal to be completely out of the sector,
but just as in the US, where more differentiation is occurring
within the TMT group as the industry matures, we suspect
this will also take place in Europe. We would differentiate within
TMT in four ways.

1. Visibility. If, for any reason, investors’ risk aversion rises, their
time horizons will most likely shorten. We therefore recommend
those areas of TMT which are currently experiencing strong
earnings growth and upgrades and where visibility is greatest for
the future. Of those reported, 1999 results have certainly beaten
expectations for the telecom equipment and semiconductor
stocks, but the same cannot be said for all telecom/media stocks
(as illustrated by BT, Deutsche Telekom, GTS and Reuters).

2. Barriers to entry. There is an increasing risk that “too much
capital is chasing too few companies” and that overall returns
may be depressed by overcapacity. The fixed-line telecoms are
currently experiencing this, with heavy competition driving
down tariffs and destroying profitability. However, as an example
of an area with high barriers to entry, Nokia, Ericsson and
Motorola, together having a market share of around 50% (and
rising) of the wireless handset market, are able to hold onto their
pricing power and are significantly better able to absorb spiraling
R&D costs at a time when volumes are exploding.

3. Nature of the business. We suspect that Europe is likely
to undergo a technologically-led capex boom in coming years,
given the low cost of capital, technology catch-up. Capex
equipment plays within the TMT group are likely to benefit.

4. Interest rate sensitivity. We continue to believe that interest
rates could rise more than equity fund managers are currently
discounting and those stocks with the highest amount of value
in their terminal value are more vulnerable under this scenario.

Bearing in mind these factors, we remain overweight IT
Hardware/ Electronics, are underweight Media, and broadly neutral
Telecoms and Software.

The sector rotation and market obsession with TMT has created
some enormous potential opportunities elsewhere in the
market. And although value alone is not a strong enough catalyst
to provoke investors’ attention, both the oils and banks sec-
tors could be beneficiaries either from a broadening out of the market,
or from a significant change of sentiment caused perhaps by
one of our suggested triggers. We still believe the global economy
has room to surprise on the upside, and there is also a high
chance that the oil price remains firmer than the market anticipates.
With current Euro weakness, cost-cutting efforts and synergy benefits
and a firm oil price driving oils’ earnings significantly higher,
we view the oil sector as one of the best plays on a continued
global upturn.

The oil sector’s price relative is almost back to Fall 1998’s lows
(when the oil price was closer to $10 per barrel), while the
prospective P/E relative of the sector is at a ten-year low. Note, the
Telecoms sector has outperformed the Oils Sector by 84% since
the start of Q4 1999. Prospective EPS Relative Price relative

European Banks have clearly been dogged by expectations of
Internet-induced structural declines in the industry combined with
rising bond yields. We suspect however, that more than enough bad news is discounted in sector valuations, and that another wave
of industry consolidation, potentially on a cross-border scale (or
even potentially involving the TMT sector), could be the catalyst
to revive the sector. However, we suspect that outperformance
from the banks could be quite limited while sentiment remains
so attached to TMT.

Previous research into sector correlations, both in Europe
and the US highlighted the significant inverse correlation
between the financials and TMT. Banks are better viewed as a
hedge against a “bursting of the bubble” rather than a long-
term theme, but are strongly favored over both insurers and life
assurers given current valuations. Our largest underweight positions,
alongside Media, are pharmas, retailers, diversified industrials
(which include German electricity stocks), transport and life
assurers. These are generally sectors whose ratings remain at risk
while their earnings are in decline relative to the market.

The resumption of talks between
Israel, Syria, and Lebanon is generating
hopes that a peace agreement
could be reached this year. Such a
development would enhance regional stability,
reduce the degree of risk perceived by
foreign investors and eventually lead to
the improvement of economic growth
conditions for the countries of the region.

The anticipated boost to regional economic
growth is expected to come from an
increased domestic business and consumer
confidence, upswing in tourism
activity, higher domestic and foreign
investment, reduced military spending,
and various forms of international support.

Because of the removal of adversarial
threats at the borders, the long-awaited
domestic economic reforms in Syria will
soon take off and will be put on a faster
track in Lebanon, Egypt and Jordan.

External factors and the reduction in
regional instability can jumpstart a development
process, but such a process can be
sustained only by a real domestic effort to
modernize the economy, liberalize the
trade regime, create a stable, supportive and
transparent legal environment, strengthen
the financial sector, and change the role of
the government from that of a “player”, or
a dominant actor in the economy, towards
that of a “referee” or a regulator in competitive
private markets.

Prospects of regional peace would
reflect favorably on the region’s overall
investment climate. It should help trigger an
investment boom in all productive sectors.
Foreign investment will be on the rise
especially in those countries of the region
that have put in place a low-cost structure
and an investment-friendly environment.

Local as well as international investors
may reconsider their stance towards the
attractively priced equity markets of
Lebanon, Jordan, Egypt, and Palestine.
Middle East stock markets have emerged at
a time of low investors’ interest and have
low correlation to other emerging markets.
Investing in these markets will provide
immediate risk diversification benefits.

Regional stability should also help
materialize strong tourism potential in the
region as a whole, a sector that is particularly
sensitive to geo-political stability.

The Middle East is uniquely endowed
with historical, religious, and natural
tourist attractions and is potentially one of
the most attractive tourist areas worldwide
assuming political stability, cooperation
between the countries in the region,
and effective regulatory measures to facilitate
mobility. Although there have been
talks of such a regional cooperative
tourism effort between Israel, Jordan,
Egypt and Palestine, real developments
have failed to materialize on the ground and
tourism activity has suffered across the
Levant. With regards to Lebanon, an
Israeli withdrawal from the South will
give the rapidly recovering tourism sector
a strong push and help it recapture its pre-
war
share in the national economy.

With a regional peace agreement in
place, Jordan, Lebanon, Egypt and Syria
would be able to capture part of the $2 billion
import market of the Palestinian territories,
so far monopolized by Israel.
Cross-border air and land transport costs in
the region will also be reduced, and this
will enhance transit trade between the
Levant and the Gulf.

The Middle East continues to be the
world’s leading arms market, both in
absolute terms and as a proportion of
GDP. The conflict between Israel and the
Arab states has been a significant factor in
the diversion of resources that might otherwise
have been channeled to foster economic
development. Normally, peace
would result in the commonality of interests
to seek security at lower levels of
armaments and find ways of reducing
spending. An anticipated reduction in military
expenditures would release substantial
resources for economic and social
development. This would be reflected in
growth rates markedly higher than those
that would have been achieved under an
animosity scenario.

It is hoped that the drive for peace in the
region would inspire the international community
to provide substantial economic
support to countries of the region. This
could take the form of increased financial
assistance during the transitional period,
debt reduction and relief that would help
countries modernize their economies.

Assuming that a favorable peace scenario           
will unfold this year, growth
prospects for the Levant economies are set
to improve. Egypt benefited from the
recovery in oil prices last year which, with
higher revenues from tourism and Suez
Canal activity, led to a rise in real GDP
growth rising to 5.7% in 1999 from 5.3% in
1998; with growth forecast at above 6% this
year. Syria, suffering from drought, saw its
real GDP growing at 0.5% last year with
higher growth of 2% anticipated in 2000 due
to the reduction in risk premium. Drought
conditions and weaker domestic demand
narrowed down growth to 1% in Jordan last
year; however activity is expected to pick
up
this year with growth rising to 2.0%.

Lebanon was in recession in 1999 with
negative real GDP growth of 1% due to a
sharp contraction in private consumption
and higher taxes. However, prospects for
peace in the region are likely to stimulate
capital inflows and investments, bringing
forth higher growth of 2.5% this year.
Growth is forecast to rise in the Palestinian
territories as well to an average of 4% in
2000, up from 3.5% in 1999.

Peace in the region is likely to create
challenges for businesses in the Arab countries
of West Asia who have to be prepared
to face new cross-border competition.

In the middle of January, Solidere

• Lebanon’s real-estate giant –
  released a list of projects that it
  had been pursuing throughout the
  past year. The firm confirmed
  that it had completed the final
  Jun-99 Aug-99 Oct-99 Dec-99 Feb-00 phase of infrastructure work and
  finished the renovation of 90% of
  ancient buildings in the downtown area. Solidere also confirmed
  continued advanced work on the Saifi residential project, as well
  as the initiation of environmental work by the US firm Radian
  International on the Normandy landfill. Solidere’s GDR witnessed
  much fluctuation in January, whereby its price varied
  between a low of $8.7 and a high of $8.8.

BLC      

Banque Libanaise pour le
Commerce enjoyed a rather rocky
month that saw it subdued by negative
sentiments following its declaration
of 1998 profits of a loss of
$4.3 million.

The bank attributed the loss to a
$16.5 million increase in provisions
and doubtful loans, which
amounted to $24.1 million.

The Bank’s GDR suffered throughout the month, whereby its price
spiraled downwards, dropping consistently from $13 on January 17,
2000, to a low of $10.85 on January 16, 2000, representing a 19.8%
drop in the GDR’s price.

BLOM

Lebanon’s largest bank in terms of
assets and customer deposits,
Banque du Liban et d’Outre Mer
SAL, declared net profits of
$70.43 million for 1999, a 20%
rise over 1998 results. Return on
Average Equity stood at 28.6%
while return on average assets was
1.46%. Total assets reached $5.08
billion, up 10.9% from 1998. Customer deposits amounted to $4.33
billion, a 12.2% rise year-on-year, while loans rose 12.49% to
$1.107 billion. BLOM announced that the results were due to a conservative
lending policy, cost containment and the launch of retail
products and services. Merrill Lynch reaffirmed its long-term “Buy”
recommendation for the stock and it also announced that it expects
the bank’s income from retail products to grow significantly in 2000
compared to fees generated from loans and trade finance.

AUDI

Bank Audi SAL, one of Lebanon’s
top five banks, declared consolidated
net profits of $38.1 million in
1999, an 11.3% decrease from 1998
adjusted figures. Return on average
equity stood at 17.1% while return
on average assets was 1.23%. Total
assets reached $3.246 billion, up
9.88% from 1998. Customer
deposits reached $2.69 billion, an
11.07**%** rise year-on-year and loans rose 0.27% to $862.2.

The Bank attributed the decrease in results to the prevailing economic
recession as well as to the cost of expansion and development.

Following the Bank’s annual earnings results, Merrill
Lynch raised its medium-term opinion on Bank Audi’s GDR from
Neutral to Accumulate, and recommended the stock as a long-term

“Buy”.

MOROCCO

A surge in turnover, led by block deals, failed to pull the
Casablanca Stock Exchange (CSE) out of negative territory
last month with year-to-date losses totaling 4.8%.

The bourse was occasionally led higher by gains posted
by the subsidiaries of the conglomerate ONA Group.
However, these gains were short-lived as the market
succumbed, driven by losses in major stocks including
Ciment du Maroc, Samir, and SMI. Although the surge in
trading activity indicates potential signs of recovery, the
market is still in need of more liquidity to be injected by
large local and foreign institutional investors to pull it out
of the doldrums.

EGYPT

Strength in the cement sector and renewed interest in a
score of blue-chip issues, along with news of falling inter-bank
rates, consolidation and privatization in certain sectors, propelled
the Cairo Stock Exchange (CSE) into positive territory.

Several reports pointing to the privatization of Telecom
Egypt with an initial tranche of 10% slated for the second half
of 2000 also added positive sentiment to the market. The stabilization
in inter-bank rates at around 15% alleviated concerns
of a rising interest rate environment following the US
Federal Reserve’s decision to hike the overnight borrowing
rate by 25 basis points in early February.

JORDAN

The Amman stock exschange recorded substantial losses
on the back of steep declines in leading industrial and
banking blue chips. The banking sector led the decline as
the heavyweight Arab Bank share lost ground after
announcing a marginal rise of 0.9% in 1999 net profit to
$225.6 million, triggering a selling spree among foreign
funds. In the industrial sector, the Jordan Phosphate
Mines Co. dropped steeply dragging the whole sector with
it. However, trading activity was strong thanks to the government’s
continued divestiture of its holdings in Arab
International Hotels as part of its privatization drive.