Looking to better times ahead

Though lower earnings will continue to add on to the volatility of the markets, one should be looking across the valley of disappointment to better times ahead.

US Stocks

Layoff announcements criss-crossed from industrial as well as technology companies, from DaimlerChrysler, ING Baring to Hewlett-Packard. A total of 133,000 job cuts were announced in December 2000. Companies are responding aggressively to the slowing economy by slashing cost, and this should provide a floor under the declining profit. Main Street is sending a message to Wall Street that management is serious about maintaining profit margins.

The latest manufacturing activities (January) fell to its lowest level since the end of the 1990-1991 recession. New orders and productions showed unusual low readings. In the 2H of 1999, the GDP was growing at a pace of 7% annual rate, and the last 6-month of 2000 was at an annual rate of 1.8%. We have witnessed a virtual collapse in economic growth. The industrial sector is experiencing no growth, whereas, the overall economy is rapidly slowing. The 4Q 2000 growth of 1.4% was the lowest since the 2Q of 1995. Furthermore, consumer confidence has taken a nosedive since last summer (143 July'00 to 114.4 Jan'01).

Perhaps the Fed has tightened for too long, realizing this mistake (belatedly as usual), Alan Greenspan has forsaken his hallmark gradualist approach in exchange for the quick and aggressive. As a result, we have seen a reduction of a full 1% point of the Fed fund rate in less than a month. The last time a cut of this magnitude occurred was during the more severe 1982 recession.

As Mr. Greenspan noted in his latest testimony that a lack of confidence can turn short, relatively painless recession into longer, more miserable one, as consumers snap their purses shut. Perhaps this is the reason that Mr. Greenspan is acting so aggressively in lowering rates, before this kind of psychology takes hold. Rather than what people are suggesting that he sees something the rest of us does not.

Improvement in monetary conditions, talks of tax cuts and regulatory rollbacks should continue to offset the drag from deteriorating profit growth. Though lower earnings will continue to add on to the volatility of the markets, one should be looking across the valley of disappointment to better times ahead.

Meanwhile, from a sector perspective, the defence, hospital management, and utility sectors look interesting, the following are stocks in each sector followed by CSFB:

Defence - new orders for aerospace equipment is picking up, so is the inventory build-up (from contracting levels) -

Boeing Company (BA $56.85) - strong buy CSFB
General Dynamics Corp (GD $69.88) - buy CSFB
Lockheed Martin Corp (LMT $36.40) - buy CSFB
Northrop Grumman Corp (NOC $86.90) - buy CSFB

Hospital management - higher payments from insurers offsetting increased labor costs -

HCA -The Healthcare Company (HCA $36.87) - buy CSFB
Tenet Healthcare (THC $44.09) - strong buy CSFB

Utility - the correction due to the power shortage crisis in California offer an opportunity. Furthermore, the Bush administration has refused to put a cap on rate charges -

American Electric Power (AEP $43.30) - buy CSFB
Dominion Resources (D $61.62) - strong buy CSFB
Duke Energy Corp (DUK $37.58) - strong buy CSFB
Entergy Corp (ETR $35.65) - buy CSFB
Exelon Corp (EXC $61.14) - buy CSFB
Pinnacle West (PNW $42.04) - buy CSFB
PPL Corp (PPL $42.48) - strong buy CSFB

US Technology Stocks

We do not expect the market to rally in the near-term in continued response to last week's 50-basis point cut in interest rates. Rather, we believe the market will continue in its profit-taking phase due to the lack of positive news expectations ahead.

Though we believe the recent 100-basis point (50bp in 3-Jan-01 and 50bp in 31-Jan-01) decrease in interest rates will help support the scenario of the NASDAQ Composite index bottoming at 2300, we expect the market to trade without any clear direction in the near-term. For the week ahead, we expect earnings release from Cisco Systems (CSCO US, $35.50, CSFB rating: Strong Buy) to compound existing volatile sentiment.

While technology companies have warned of a slower revenue growth regime ahead, CSCO has so far remained silent regarding revisions to their forth-coming quarterly results. Investors will be focusing on CSCO's announcement this Tuesday and will be alert to the company's guidance for the rest of the year.

AOL-Time Warner (AOL US, $47.79, CSFB rating: Buy) reported strong 4Q00 results with losses that widened to $1.09 billion due to increased costs related to it's $124 billion purchase of Time Warner Inc. Net income fell to $37 million while EPS exceeded expectations by 1 cent at $0.15 a share. Total revenue rose 8.2% to $10.2 billion ($9.46 billion in 3Q00). In terms of revenue mix, AOL-Time Warner's (1) subscription revenue, which accounts for 40.6% of total revenue, grew 13% yoy, (2) advertising and commerce expanded 24% yoy (24% of total revenue) and (3) content increased 2% yoy (35% of total revenue). We continue to like AOL. As of 12 December 2000, AOL alone had increased its subscriber base by 8.5% sequentially and 30.2% year-on-year (yoy) to 26.7 million AOL-branded users. With a total of about 130 million paid subscriptions (49 million from Time Inc, 37 million from HBO, 27 million from AOL, 13 million from Time Warner Cable, 3 million from Compuserve, and 1 million from RoadRunner), the new AOL-Time Warner company is well positioned to maintain its revenue projection of about $40 billion (+12-15% annually) in 2001. However, we believe the stock will continue to weaken in the near-term as investors worry about the impact of reduced corporate spending budgets and a slower US economy, to AOL's growth potential for the year. We recommend to accumulate the stock as price approaches $38.00 (12-month price target at $60.00).

Applied Materials Inc (AMAT US, $47.75, CSFB rating: Buy) remains trapped in a $20 trading zone. Though we expect AMAT's stock price to weaken further from current levels, we believe the downside risk to its stock price is relatively small at $35.00. AMAT pre-announced 1Q01 results that were lower than analyst forecast but yet within market expectations. EPS estimates have been revised down to $0.60 (from $0.74) a share. Revenues are expected to come in lower at approximately $2.60 billion (from an expected $2.93 billion) as order delays and cancellations remain in acceleration mode. We are cautious in the near-term as we believe the company will continue to experience a weak ordering environment as demand slows in the 1H01. Nevertheless, we are hopeful for a recovery in revenue growth from 2H01 onwards as the semiconductor demand-supply imbalance levels off. Accumulate on weakness at around $36.00 (12-month price target at $55.00).


Europe

The recent economic data and outlook statements of companies have triggered further doubts whether a quick recovery (V-shape) in 2H01 would still be in the cards. CSFB's economists continue to view this as the central scenario (2H01 US-GDP growth 3.3%) with a likelihood of 60%. So far the market reaction has been similar to October 1998 with cyclicals outperforming the market since the FED started to cut interest rates. However, the high leverage of consumers and the apparent excess capacity in the technology sectors make investors increasingly worried about the scenario of a hard landing. Consequently, sentiment could deteriorate further in the short term before a sustainable recovery is possible. Despite this, we believe that the benefits of the FED's actions will eventually kick in and turn markets around, which supports our strategy of using the Q1 and maybe Q2 weakness to build up positions with an investment horizon of 12 months. Despite the high correlation of European equities to the US market we believe that economic growth in Europe should do fairly well. We estimate that the fiscal easing (adding 0.7% to GDP) and the stronger Euro, which might allow the ECB to lower interest rates will act as a solid protection.

Assuming the above scenario we added Rhodia (RHA FP; EUR 16.42) to our recommendation list. Rhodia is the world's third-largest listed specialty chemicals company, which was spun off form Rhone-Poulenc and Hoechst in 1998. The company generates more than 60% of sales in Europe, 20% in USA and 10% in RoW (Rest of World). Typically, chemical stocks outperform the market post a steepening in the yield curve. This steepening has started after the FED cut interest rates and is likely to go on for a while. In other words, the sector performs on the interest rate stimulus to economic recovery, not actually on the recovery itself. We expect the lower oil price to offset an eventual slowdown in volumes. Rhodia's valuation is undemanding. The stock trades at a P/E01 ratio of only 9.84x and 4.8x EV/EBITDA01, which compares to a sector average of 6.5x. We believe that the synergies of the drastic restructuring program have not been reflected in the valuation. We expect the stock to reach our target of EUR 19 this year, which implies an upside of 15.7% from current levels.

Nokia (NOK1V FH; EUR 35.60) reported 4Q-earnings broadly in line with expectations. The disappointing margins and reduced 2001 guidance caused Nokia shares to fall 11.55% for the week, back to the level of November 1999. Nokia expects 1Q01 to be at the same level like a year ago. This is clearly a negative and underlines the margin pressure in the industry and the difficult economic environment. However, Nokia stuck to its 1H01 sales target to be at the top end of its sales range of 25-35%, indicating a recovery in 2Q01. We expect the stock to remain under pressure in the short-term and to trade in a range of EUR 35-45 until visibility in the industry becomes clearer. We recommend long-term investors to hold the stock. Further weakness should be used to build up positions.

Siemens (SIE GY; EUR 152.40) reported a Q1 FY01 profit increase of 32%, which was slightly ahead of consensus. In line with most other companies Siemens expects a more difficult environment in the quarters ahead but is confident to reach double-digit earnings and sales growth in FY2001 (ending in Sept.).

Infineon's (IFX GY; EUR 45.08) earnings came in ahead of lowered estimates. The management expects computer memory chip prices to stabilise during the course of the year. We remain cautious on Infineon since DRAM prices have started to decline again after a period of recovery. We see a downside risk of EUR 40-42, where we would be buyers of the stock in anticipation of the DRAM recovery in 3Q01.

Deutsche Bank (DBK GY; EUR 96.70) reported a decline of 7% in 4Q00 profit. Shares declined on concerns about the underlying quality of the earnings as costs and one-time items were much higher than expected. CEO Breuer expects 2001 to become difficult. Deutsche Bank announced details about its restructuring plans. It will reduce its business units from five to two, one focusing on companies & institutions and the other one on retail banking and asset management.

We consider these measures substantial as the changes will result in 1.5bn annual cost savings and job cuts of 2600 staff. We expect the stock to consolidate in the near-term. Short-term investors should use a recovery to take profits. In the long run Deutsche Bank remains one of the best plays on the structural changes in Germany.

Among companies reporting earnings this week are

Schering - February 7,2001
Philips - February 8, 2001
Royal Dutch - February 8, 2001


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