Fine tuning of forward looking expectations (page 1 of 3)

US Stocks

Last week, we talked about the amount companies spent on their R&D in order to ensure their competitiveness and future growth. This time, we focus on the companies' ability to finance those spending from cash generated from their operations. The companies with the R&D-to-cashflow ratio over 100% will have to either:

· Increase operating income
· Increase financing
· Decrease R&D spending
· Lower cost

The first two options are either unrealistic or not desirable given the current market conditions. To lower R&D might cause the companies to loss market share permanently and play catch-up. Lowering cost will have its limits and may affect other business units. In the short term, these companies may rally due to their relative oversold positions. But the longer the economy stays down, the more they will have problems going forward, particularly the ones with ratio of 300% or more.

The manufacturing companies like GE, Boeing, & Eastman Kodak will not face this problem, so are the financially sound companies like IBM and Microsoft.

US Technology Stocks

On a week to week basis, the NASDAQ Composite Index fell a further 6.7% to 2262.

Continued negative news flow from "blue chip" technology companies should keep sentiment weak, but at the same time, should also help further fine-tune forward looking expectations to incorporate a feeble revenue growth regime.

Sun Microsystems' (SUNW US, $20.8125) profit warning not only confirmed the bleak revenue growth outlook within the technology hardware space, it also helped force investors to accept the reality that customer spending has slowed and that a recovery in revenue growth is still an uncertain event in the near-term. Nevertheless, we believe SUNW's downside risk in price is relatively muted at $18.00. We expect SUNW's stock price to trade in consolidation at current levels as long-term investors begin accumulating the stock for a 1H02 performance. Looking 12-months ahead, we recommend strategic investors to adopt a 3-tiered accumulation strategy for the stock. We suggest exploring a first-tier accumulation entry point at $18.00 (to capitalise on any near-term price rebound) and a second-tier buy level at $13.00 (if price continues to depreciate instead). We would hold-off the third-tier accumulation level (as a reserve) until falling prices stabilise. This accumulation methodology helps strategically position our investments in a disciplined format and at the same time capitalise on short-term sentiment.

Looking ahead, we remain focused on the downside risk of 2200 (potentially strong floor) as a possible consolidation area where (we believe) value-hunters will begin accumulating stocks. However, the risk to 2200 failing to hold will now rest with overly optimistic expectations for further interest rate cuts (time of cut and size of cut) in the short-term. Technology investors and traders have begun to price-in positive interest rate movements over the next few weeks. As such, over the near-term, we expect a rebound in price to occur. If over time, on the other hand, the Fed decides not to change the interest rate policy in their meetings, the risk will then be on short-sellers taking-over the driver's seat and navigating NASDAQ lower to 1800.

Europe

There seems to be no improvement in sight for equity markets. Economic data from the US continue to cause a state of confusion after the CPI figures re-launched the topic of inflation in an environment of rapidly declining economic growth and corporate profits.