Preference for technology and financial stocks

Defensive sectors continue to underperform, implying that investors' risk appetite is increasing. This favours our preference for technology and financial stocks.


US Stocks

In a recent Technology Review publication, it was reported a MIT graduate built the "perfect mirror" - one that reflects light from all angles with negligible absorption. In theory, a mirror-lined coaxial cable can carry light of higher intensity and a broader bandwidth, transmitting up to 1,000 times more data than fiber optics. According to the inventor of the technology, we are getting closer to the capacity of the conventional optical fiber in a few years time.

In addition to transmitting more data, the new cable could eliminate the need for signal boosters every 60 to 80 miles. And, unlike the fiber optics, the cable will have no trouble transmitting light around sharp bends, allowing the cables to be miniaturized to the scale of the tiny optical switches being developed for the optical Internet.

Does this development spell the end of the fiber optics and boosters manufacturers? Not necessarily, because there is the question of legacy. It is economically not feasible for client who has already committed to the fiber optic technology to change every time a new technology comes up. Furthermore, the above-mentioned innovation has yet to attain commercial viability, and therefore, profitability.

In this fast pace of technological innovation, today's technology will be rendered obsolete in the not too distant future. But this does not mean the best technology will always wins out. Witness the case of Microsoft's operating system and the Linux, and perhaps the most famous example - the Sony Betamax against the VHS.

We have to be aware that we tend to be mesmerised by what the new technology promised it could do. Rather, one should not neglect the management record/leadership, diversity of existing product lines, balance sheet, earnings and valuation (given a reasonable future growth rate).

The purpose of this exercise is to look for fundamentally sound companies in an oversold situation. And with the stocks from our buy list particularly in mind, I have come up with the following. The idea is to treat these stocks as a separate asset class a recovery situation. The performance from the beginning of last year have ranged from -37% to -65%, and depending on client's risk appetite & time frame, 10% to 15% of the portfolio should go into these stocks. Then wait out the next 18 to 24 months for them to recover along with the business cycle.

The list represented different sectors of technology - software, cellular phone & telecom chip, telecom service, content provider, & computer manufacturer. At current levels, a little bottom fishing is in order for these stocks.


US Technology Stocks

After three consecutive "up" days on NASDAQ, the market took a pause on Friday as investors prepared for the long weekend (holiday on Monday to mark Martin Luther King Jr. Day). On a week-on-week basis, the NASDAQ Composite Index gained 9% to settle the 2nd trading week of the new year at 2626 (+6% year-to-date performance). Looking into the week ahead, we expect profit results from preferred tier one technology companies to set the pace for 1H01 investments into technology stocks. We expect volatility to be high and as such, we do not recommend buying these stocks during this "noisy" period.

Gateway's (GTW US, $21.10) and Hewlett-Packard's (HWP US, $30.69) weak earnings announcement last week will continue to dampen sentiment for related computer hardware stocks. Though price reactions last week were muted, we believe investors will continue to shy away from GTW and HWP, as well as other PC-related issues. While end-user demand for computer hardware did not improve during the Christmas season, we expect the demand environment to remain weak in 1H01 and begin moderating only in 3Q01. We expect the sub-sector to under-perform during 1H01.

Strong 1Q01 results from Ariba Inc (ARBA US, $35.19) failed to spur investors to take the stock higher as slower sequential revenue growth (down from 37% in 1Q00, 71% in 2Q00, 102% in 3Q00 and 67% in 4Q00) capped bullish sentiment. Though 1Q01 EPS of $0.05 beat analyst expectations of $0.03 a share, investors were concerned about potential decelerating demand and the lack of visibility on recurring revenues ahead. Nevertheless, ARBA posted healthy results with total revenue that expanded 625% year-on-year (yoy) and 26% quarter-on-quarter (qoq) to $170.2 million. License revenue grew 717% yoy (30% qoq), network revenue climbed 694% yoy (29% qoq) and services revenue increased 247% yoy (-2% qoq). Though rising sales and reduced marketing expenses helped enhance operating margins to 10.6% (from -4.7% in 4Q00), day sales outstanding figures however, increased from 41 days to 63 days. We expect ARBA's stock price to remain depressed in the near-term as investors continue to focus on the slower growth prospect of the company.

America Online's (AOL US, $46.47) approved merger with Time Warner was greeted with subdued enthusiasm as investors digest the FCC's additional requirements of (1) implementing an advanced version of AOL's instant messaging service that has the ability to operate with competitor services, and (2) providing consumers a choice of Internet service providers (and allow ISPs to control their own start page) on Time Warner's cable line network. We do not believe these additional requirements will dull the company's competitive advantage. We expect AOL-Time Warner's stock price to higher over the next 12-months. Maintain Buy (CSFB rating: Buy). 12-month price target at $75.

Europe

We are only two weeks into the new year but markets have already undergone a pretty massive roller coaster. While the European STOXX 50 performance of -0.20% would indicate a slow start, a closer look at the underlying sector performances shows that there is an important shift taking place now. With defensive sectors such as insurance, food & beverage and healthcare losing between 8% and 14% and telecoms and banks gaining 13% and 4.36% respectively we feel that investors are prepared to take a slightly more aggressive stance going forward with a clear focus on quality and valuation. Even though the next few months are most likely to be bumpy we see value in some selected stocks.

Nokia's (NOK1V FH; EUR 43.86) sales figures hit the market by surprise. Nokia reported an increase in sales of 64% in 2000 with 128 million handphones sold. The company estimates that worldwide 405 million handphones were sold. This accounts for a market share of 31.6%. The market took the 405 million as a disappointment since the consensus was closer to 425 million. Consequently, investors were afraid of a slow-down in handset sales and lower profits of equipment makers. We do not share the opinion that Nokia's sales figures were disappointing and chances for an earnings surprise are still intact. In fact, we believe that Nokia has managed to increase its market share in 4Q00 with an above estimate 39.5 million handsets sold. According to analysts there was only limited price erosion in the market during 4Q00.

While the number of handsets sold increased by 43% we expect a relative slowdown in growth, which we believe will take place as certain markets reach 65%+ penetration. We expect that 525 million handphones will be sold in 2001, which still reflects a growth rate of 30%. Less developed markets such as China present tremendous growth opportunities of 50%+ as carriers play catch-up to the heavily penetrated markets. We estimate that Nokia will extend its lead over Motorola and Ericsson in 2001 obtaining a market share of 35% or 185 million handsets. This implies an above-industry growth rate of 44.5%. We expect Nokia's share price to remain volatile until it releases earnings. We recommend using a level below EUR 40 to buy the stock.

Vodafone (VOD LN; GBP 2.36) reached a new 20-month low of GBP 2.17. Hutchison launched a USD 2.5bln exchangeable bond into shares of Vodafone. Additionally, rumours that Banco Santander might sell some of its shares in the second half of 2001 were responsible for the sell-off. We believe that the problem of the share overhang on Vodafone might prevent the stock from a short-term rally. However, we believe valuation is attractive and the launch of GPRS (Global Packet Radio System) later this year might improve the newsflow.

This week the first European technology companies start to report earnings. Major companies are expected to report on the following dates.

ASM Lithography, 18 January, 2000
STMicroelectronics, 19 January, 2000
SAP, 23 January, 2000
Ericsson, 26 January, 2000
Nokia, 30 January, 2000
Alcatel, 31 January, 2000
Siemens, 31 January, 2000
Infineon, 31 January, 2000

Insurance stocks such as Munich Re (MUV2 GY; EUR 348.95) and Zurich Financial Services (ZURN SW; CHF 927) had a slow start into the new year. As we pointed out in earlier 'weeklies' insurance stocks tend to react on an anticipated decline of interest rates. We believe that the longer-term fundamentals (tax & pension reforms in Europe) are still intact. We view the current declines as a result of higher risk appetite and profit taking after a strong performance.

Carrefour (CA FP; EUR 62.55) reported disappointing December sales. While like-for-like sales in Spain showed some improvement, sales in French hypermarkets declined. The reasons remain the same (store conversions, change in product range, Latin America) but we believe that the second half of the year will show some improvement. The current share price reflects a lot of bad news. Even though the recovery might take a bit longer, we consider the medium-term downside limited and the upside significant.


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This document has been prepared solely for information purposes and for the use of the recipient. It does not constitute an offer or an invitation by or on behalf of Credit Suisse to any person to buy or sell the security. Any references to past performances is not necessarily a guide to the future. The research and analysis contained in this publication have been procured by Credit Suisse and may have been acted on before being made available to clients. For further information, please contact your investment advisors or Investment Consulting.