Final leg of a correction has historically been very volatile

US Stocks

It was not an enjoyable downward roller coaster ride last week. The major stock indices lost over 7%. The 'non-tech' blue chips felt the weight of the declining NASDAQ and finally buckled. For the week IBM lost over 9%, Boeing - 18%, Eastman Kodak -6%, 3M -9% and GE -7% to name a few. Not even the low beta stocks like Coke and RJR were spared loosing 5% and 8% respectively.

Is this the final blow-off? The volume certainly does not suggest so and neither do we see a capitulation because volatility remains high.

A 50b.p cut is already in the cards on today's FOMC meeting and the surprise will be how much more? On one hand, a raft of data shows nervous consumers a drastically slowing economy and a deeply depressed manufacturing sector coupled with a badly savaged stock markets. On the other, consumers are still spending, the unemployment rate is at 4.2% (just above a 30yr low) especially coming out from the state of California despite a statewide energy crunch and the national downturn in technology spending. Furthermore, the housing market remained firm.

The earnings result season is upon us again, this week Morgan Stanley, Goldman Sachs, Lehman Brothers and Bear Stearns are scheduled to release their 1Q earnings report and others will follow. So, fasten your seat belt.

US Technology Stocks

Last Friday's close on the NASDAQ Composite index at 1890 (down 7.8% week-on-week) effectively erased all performance gains since the beginning of 1999!

Looking ahead, we believe weak earnings results (for the March quarter) and poor forward looking statements from technology companies will continue to fuel sentiment towards short selling activities. As we enter into the quarterly earnings reporting season in April, we believe volatility will be high from company profit warnings and short-covering activities. Investment sentiment in the near-term will be strongly influenced by short-term interest rate policies and expectations for the year.

On company specifics, Oracle Corp's (ORCL US, $14.0625, CSFB rating: Downgrade to Buy) stock price fell 14% last week as investors remained negative on the company's near term prospects. Last week, ORCL released 3Q01 results, which met revised estimates, and further warned of sustained weakness in demand ahead as business sentiment remained poor due to the uncertain US economic outlook. ORCL posted 3Q01 revenues that grew 0.6% sequentially and 9.2% year-on-year. Earnings per share of $0.10 was in-line with revised estimates, while its cash (and equivalents) position continued to improve, advancing 14% sequentially, to $5.0 billion. Meanwhile, Deferred Revenue and Day Sales Outstanding were unchanged at $1.0 billion and 66 days. With near-term demand visibility being poor and an IT spending "lock-down" in place, we expect ORCL to be well challenged to restructure its business strategy to overcome the deceleration in earnings momentum and revenue growth. Currently, ORCL is proactively changing its marketing efforts to emphasize rapid implementations (CRM implemented in 90 days and Internet Procurement in 30 days) and speedy return on investments. We continue to like ORCL in the long-term but remain cautious in the short-term. Looking ahead into the week, we believe ORCL's stock price has the potential to fall further, and as such, we do not recommend buying the stock yet. Instead, we suggest allowing price to stabilise first before adopting an accumulation strategy for the stock.

Europe

We are convinced that the declines over the last few weeks and the lower interest rates have brought us somewhere closer to the bottom. However, the final leg of a correction has historically been very volatile, driven by sentimental rather than by fundamental factors. Over the last few days the sell-off has gone far beyond the burst of a bubble, it has in fact spread over to the defensive sectors that were so far considered as a safe haven. The fact that financials suffered badly over the last few days on the back of concerns about the health of Japanese Banks and the spill-over effect on other global banks does in fact call for some urgent actions from the policy side.

We believe it is still too early to come back to technology stocks. The still deteriorating earnings visibility means that a sustainable recovery will need more time to materialise. Temporary rallies can be expected but they will be of technical rather than of fundamental nature and will be used by investors to reduce overweight positions. Even though we believe that valuations start to look attractive in a long-term view, we consider risks still higher than return opportunities. We would enter the markets only under a long-term approach and in several steps. We do not believe that there is a high risk in missing a strong rally unless massive changes on the macro front are announced.

Ericsson (LMEB SS; SEK 57.5) warned that its first quarter revenue and pre-tax profit would fail to meet the guidance issued at the end of January. It cited problems across its major divisions noting that its handset business faced an increasingly difficult outlook and that the infrastructure division saw slower demand, especially in the US. We believe that Ericsson continues to lose market share with its largest US customers as the GSM/GPRS rollout offers gains to Nokia.

Nokia (NOK1V FH; EUR 27.37) lowered its sales growth expectation for 2001 to 20% from 25-30%. 1Q01 EPS will be unchanged at EUR 0.19, which is in line with forecasts made when they issued the 4Q00 report but ahead of market consensus of EUR 0.16-0.18. This is clearly good news since Nokia manages to meet its forecasts with lower sales, which indicates that margins have held up remarkably well. The mobile market share has been extended to above 32%. Nokia cut its mobile handset market estimate for 2001 to 450-500m, which is below the current market consensus of 490m. We believe that Nokia has proven that they cannot avoid the global downturn but they have given confidence that they are in a position to weather the storm better than its competitors and have proven that they are able to benefit from their weaknesses.

The stock could have a short-term rally but we believe that no sustainable recovery is possible without better visibility from the macro-picture. We, therefore, retain our HOLD rating. Investors, however, who are not yet invested in Nokia can start buying an initial position with the intention to top-up should the stock come back to the old levels of around EUR 24.

ST Microelectronics (STM FP; EUR 36.8) issued a pre-announcement lowering earlier guidance. The company said that 1Q01 earnings will now be at around USD 0.39 down from USD 0.42. The new forecast is in line with the current analyst consensus. STM said that capital spending will be reduced to USD 1.9bln down from USD 2.5bln and margins will decline to 44-45% from 47.4% in 4Q2000. The company blamed weakening demand in its digital consumer and commodity business and said that sales in the telecom and flash memory products remained strong. This statement comes as a relief but nevertheless it is not a confirmation that industry fundamentals have bottomed by now as overall demand conditions continue to deteriorate delaying the impact of supply adjustments. We continue to believe that STM will outperform the industry and see the fastest recovery of all European semiconductor stocks once the fundamentals improve. However, we are not there yet although valuations start to look attractive. We reiterate our HOLD.

Cap Gemini (CAP FP; EUR 159.5), the world's no. 5 IT consulting company, reported solid full year results. The integration of Ernest & Young Consulting (E&Y) appears to be largely complete. The key issue remains the ability to realise the potential of the platform. CAP's brand, skills base and focus makes it one of the best positioned stocks in Europe to exploit the return to efficiency driven IT spending. The stock trades at 33 revised 2001 EPS implying a PEG of 1.57. Whilst this is not cheap, we believe that CAP is the only European services stock with genuine global reach and that there is substantial scope for margin enhancement going forward. In addition, CAP is one of the few tech stocks that show a bottoming pattern.

We get increasingly concerned about the spill-over effect of the earnings worries on the defensive or interest rate sensitive sectors. These sectors had good rallies since the 2H00 when technology shares experienced their steepest decline ever. Valuations in the defensive sectors do not leave any room for disappointments in our view. Hence, we take profit or loss on the following recommendations:

We take profit on Munich Re (MUV2 GY; EUR 320.20). The insurance sector has underperformed the overall market year-to-date. We believe this is due to fair valuations at current levels and hence limited upside as investor's focus will increasingly shift to the cheap and/or battered stocks (i.e. cyclicals & technology stocks). MUV2 has reached a critical point on the chart and we consider the risk of the stock dropping to EUR 300 as higher than the upside. We think the fundamentals of the company remain very attractive, especially in the long-term due to the effects of the tax and pension reforms in Germany. Since our recommendation, MUV2 has performed excellently on a relative basis. While the DJ Stoxx Europe and the insurance sub-sector were down 17% and 6% respectively, MUV2 gained 1.6%.

We take a profit of 24% on Aventis (AVE FP; EUR 82.05). We believe that fundamentals are still very much in tact and valuations on a EV/EBITDA basis does not look stretched compared to competitors. However, the stock rallied from EUR 50 to 90 in the last twelve months and has since traded sideways. We believe that the stock's upside is capped at EUR 90 for some time and it would need an external trigger to break this level. In the short-term, we consider the chances of a further decline higher.

We take loss on ABN Amro (AA NA; EUR 21.41). The earnings report was a disappointment. The higher costs were clearly against the management's promises and it now seems very ambitious for ABN to reach its 17% ROE target. We believe that a lot of damage was done to the restructuring story we wanted to play. We believe it will take much longer for ABN to convince the market that its strategy is sound and implemented consequently. The valuation of only 9.3x P/E02 reflects the market's concerns and is not enough to form a support to the stock. In addition, ABN has operations in the US which are another threat to the company's demanding profitability targets. We believe that earnings downgrades are on the cards for ABN and hence take a loss of 21% since our stop-loss level of EUR 23 was broken.

Zurich Financial Services (ZURN SW; CHF 685) has performed badly over the last few weeks. First we had a profit warning and then a general sell-off in insurance stocks. The reason for the under-performance has clearly been the negative press surrounding the company. ZURN might have to admit that there are significant losses in its investment portfolio should the allegations be true. However, at this point in time these are rumours. We feel that risks have increased ahead of Thursday's earnings presentation and, therefore, reduce the stock to HOLD until we will get further details.