Oct. 17 (Bloomberg) -- European drug and telephone stocks may outperform the market through year-end as investors turn to companies most likely to weather any economic slump triggered by higher interest rates.

``There's a search for a safe haven at the moment,'' said Markus Steinbeis, who manages about $11 billion at Activest Investment GmbH in Munich, ``Telecom and drug stocks are a good place to be.'' His holdings include AstraZeneca Plc, the U.K.'s second-largest drugmaker, and Telekom Austria AG, the country's biggest phone company.

The two industries are the quarter's leaders among 18 groups in the Dow Jones Stoxx 600 Index, a pan-European benchmark, which has lost 2.9 percent amid concern that central banks may increase rates to contain inflation. The drop is the steepest ever at the start of a fourth quarter for the index, calculated since 1987.

Last week, the Stoxx 600 health-care and telecommunications index both slipped 0.9 percent, less than a 1.1 percent loss for the regional gauge.

Drugmakers and phone companies are among the favorite industry groups for European fund managers, according to Merrill Lynch & Co.'s latest monthly survey. This month's results will be published tomorrow.

Novartis AG and Roche Holding AG, Switzerland's largest drugmakers, may report higher third-quarter earnings and sales this week. The first major phone company to report is Sweden's TeliaSonera AB on Oct. 25.

Hurt by `Trade-Off'

The Stoxx 600 peaked at a 3 1/2-year high on Oct. 4 and then retreated after Federal Reserve Bank of Dallas President Richard Fisher said U.S. inflation is near the upper end of a tolerable range. Consumer prices rose last month by 1.2 percent, the most since 1980, the government said on Oct. 14. The Fed's benchmark rate has risen 11 times since June 2004, to 3.75 percent.

European Central Bank President Jean-Claude Trichet said on Oct. 6 that policy makers are more concerned about inflation and prepared ``at any time'' to raise rates. The ECB's benchmark rate has been at 2 percent, a six-decade low, for more than two years.

Last week's decline in the Stoxx 600 compares with a 0.9 percent drop in the Stoxx 50, tracking some of Europe's biggest companies. The Euro Stoxx 50, a gauge of the 12 countries sharing the euro, slipped 0.7 percent.

``The trade-off between growth and inflation in the near term will be negative for equity markets,'' said Mislav Matejka, a strategist at JPMorgan Chase & Co. in London, in an interview. He advised investors to hold more drug and phone stocks than are represented in equity benchmarks.

Differing Moves

For the quarter, the Stoxx 600 drug index has risen 0.4 percent, the only advance among the benchmark's industry groups. The phone index has slipped 0.5 percent. They are the third- and fourth-largest industries by weighting, respectively, in the Stoxx 600 and together account for 18 percent of its value.

The two groups haven't moved in lockstep this year. Pharmaceutical companies, aided by gains in the dollar against the euro and British pound, rank third behind raw-material and oil and gas producers. Phone companies trail every industry except retailing amid concern that competition and flagging growth in fixed-line businesses will hurt results.

Drugmakers are the ``prime beneficiary of any rebound in the dollar,'' said Stephen Ford, who helps oversee $28 billion for Brewin Dolphin Holdings Plc in London. More than half the revenue for AstraZeneca and GlaxoSmithKline Plc, the region's two biggest drugmakers, comes from North America.

AstraZeneca, Novartis

AstraZeneca on July 28 boosted its estimate of full-year earnings after quarterly profit rose 50 percent. Shares of the company have advanced 2.1 percent this quarter. GlaxoSmithKline, which agreed last month to acquire Canada's IBM Biomedical Corp. for C$1.7 billion ($1.4 billion), has gained 0.9 percent.

Novartis will probably say tomorrow that third-quarter net income rose 8.3 percent to $1.59 billion, according to the median estimate of eight analysts surveyed by Bloomberg News. The shares have risen 0.5 percent for the quarter and 15 percent this year.

Roche, which doesn't report quarterly earnings, may say on Oct. 19 that third-quarter sales rose 15 percent, according to the same survey of analysts. The shares have risen 2.5 percent this quarter and are up 41 percent this year.

Companies such as Roche are benefiting as countries seek to avoid a possible outbreak of bird flu. The European Union on Oct. 10 warned that a pandemic caused by a strain known as H5N1 could kill millions of people and urged governments to stockpile drugs made by GlaxoSmithKline and Sanofi-Aventis SA, as well as Roche.

Rising Estimates

Analysts expect average earnings at Stoxx 600 health-care companies to increase 23.1 percent in 2005, up from 19.7 percent on June 30, according to Bobby Rakhit, an associate director at FactSet Research Systems Inc. in London. The average for phone companies has also risen, to 13.7 percent from 11.2 percent.

Telekom Austria said on Aug. 24 that second-quarter profit more than doubled, helped by sales growth at international mobile- phone units and lower interest and tax payments. The shares have risen 0.7 percent this quarter.

Phone stocks have benefited from a pickup in takeovers this year along with earnings growth. France Telecom SA and Telefonica SA have led about $95 billion of purchases, up from $42 billion a year earlier, according to data compiled by Bloomberg.

Franz Wenzel, senior investment strategist at Axa Investment Managers in Paris, said it's too early to purchase drug and phone stocks. Instead, he is buying shares of energy, raw-material and industrial companies.

The Right Economy

``We're convinced growth is going to recover,'' said Wenzel, who helps oversee $464 billion in assets for Axa. ``Inflation is a problem but we're not convinced this is an enduring phenomenon. We don't recommend switching into defensive stocks right now.''

Merrill's survey showed many investors would disagree. Forty- three percent of respondents in September said they had more shares of drugmakers and telecommunication companies than are represented in benchmarks. The percentages were the highest for an industry group besides energy producers.

``It's certainly a good time to get into telecom and drugmaker stocks,'' said Justin Urquhart Stewart, part of a team that oversees $940 million at 7 Investment Management in London. ``The economic environment'' ought to favor them, he said.

To contact the reporter on this story: Chris Fournier in Frankfurt at Cfournier3@bloomberg.net

Last Updated: October 16, 2005 19:23 EDT