Close to bottom but still some distance from recovery

US Stocks

Manufacturing capacity started its above average growth back in 1995, and hitting a high on 1998 with a rate of 7.3%. Although the rate of growth slowed in 1999 & 2000 due to the impact of the economic turmoil in Asia, but it remained above the average. The bulk of the increase came from three industrial groups:

-Computer & Office equipment
-Electrical Machinery
-Semiconductors & Related Electronic Components

From 1996 to 2000, the average capacity growth rates of the above groups were 46.5%, 27.4%, and 52.2% respectively, this compares with the average total industry growth of 5.4% for the same period.

The industry groups only made up a small percentage of the total industrial production (IP), combining for 14.4% of total IP as of 1999, as oppose to 48% for durable manufacturing, 40% for non-durable manufacturing, with the largest portion going to the electrical machinery at 8.5%.

The utilization rate for computers & office equipment was below 80% at the end of 1999, and was at 79% 4Q 2000. As for the other two groups, it is still above 80% but declining as demand slows.

The result will not only be inventory build-up, but idle capacity. The recent rate cuts should keep consumer spending up, working off the excess inventory. But it is unclear whether this is sufficient to deal with the slowing hi-tech investment spending. If not, then write-offs will further put pressure on an already fragile earnings base.

From an investment perspective, we know where the potential excess capacities are. Stay focused on quality companies with good value that have the cash flow and market share to overcome these problems i.e. IBM (IBM $96.18), Microsoft (MSFT $54 11/16), and industrial groups that have no capacity issue like RJR (RJR $56.10).

US Technology Stocks

Near-term investment sentiment remains depressed, and investors are still unsure about committing cash to buy technology stocks. With the quarterly company earnings reporting season currently in place, we advocate the conservative strategy of "sitting on the side-lines" as we believe prices will be trading without any clear and sustainable direction during the period.

On a year-to-date basis, the NASDAQ Composite index registered a negative performance of -25.5% (closing down -4.5% to 1840 last week). Looking into the week ahead, it is still relatively early to conclude if declining prices have found a floor as the strength of current sentiment may weaken further on any unanticipated negative company-related news ahead, and subsequently drive technology stock prices lower. As such, we maintain our cautious stance on NASDAQ in the near-term.

Maintain Hold on Nortel Networks (NT US, $14.05, CSFB rating: Buy) and remain cautious in the near-term. Earnings warning from NT sparked renewed jitters among already bearish investors and reinforced the demand-slowdown scenario within the telecommunications equipment market. NT's management now expects March-1Q01 sales to come in below expectations and a deeper EPS loss than anticipated. Competitive pressures have been exacerbated by a reduced end-demand environment and the resulting "buyers' market" have continued to squeeze margins thinner. Nevertheless, we believe NT is well positioned to significantly improve performance in 2002 and be one of the first few to break out from the prevailing depressed mode.

NT continues to boast the next generation product portfolio relative to all other system integrators. While NT's valuations have approached attractive levels, we do not recommend buying NT yet as we expect the stock price to trade in consolidation (due to the limited visibility to a demand recovery). NT trades at multiples of 19x Price-to-Earnings, 1x Price-to-Sales and Price-to-Book (source: Bloomberg). We expect more forward looking guidance from the company's management when they report results on 19 April 2001. Meanwhile, we maintain our Hold recommendation on NT.

Europe

The first quarter of 2001 was a horrible start to the new year. The Euro STOXX 50 lost 12.31% (18.30% in USD) based on growing fears about the duration of the US economic slowdown and its impact on corporate earnings. Only two (automobile & construction) of the 18 sectors compiled by STOXX managed to post a positive performance, with technology being the leading decliner posting a loss of 32.67%! Apparently, the rapid pace of downwards revisions in February and March are the responsible factors for this disappointing performance. For Europe as a whole, 2001 estimates now stand at 8.5%, having been 14% in February 2000 and 11% at the start of the year.

Sectors with the worst revisions to 2001 EPS forecast over the past three months are technology (-18%), industrials (-8%) and consumer cyclicals (-7%), while energy was the only sector that received a 2% upgrade. Whilst there is still scope for further downward revisions to 2001 estimates, perhaps leaving aggregate growth estimates a couple of percentage points lower from here, it seems likely that the worst of the downgrades are now behind us.

However, while we feel that most companies will make their numbers on the reduced basis we remain very cautious about their guidance for the second quarter. As pointed out by Nortel Networks earnings visibility remains extremely low, especially in the technology sector. As long as we see no improvement in this point earnings downgrades will continue and markets have simply no reason to start a sustainable rally even though a great deal of negative news might be priced at this level. We might be close to bottom but we are still some distance from a recovery.

Our cautious stance is further underlined by the fact that European economies start to feel the impact of the US slowing and that the ECB has missed another opportunity to lower interest rates. Even though a rate cut might happen in two week's time it would have been an opportunity for the ECB to prove that they were on top of things. We feel that the growing sensitivity for European growth might weigh negatively on European stocks, especially for those with a large European exposure.

The good news for the week was the re-emerging topic of the consolidation story in Europe. Finally, the German banking sector started to move, a step that has been expected for years but never came through due to structural deficits. Allianz's (ALV GY; EUR 327) offer to buy Dresdner Bank (DRB GR; EUR 51.39) marks the first big deal of cross-holding unwinding, which is now possible due to the German tax reform. This deal might just be the beginning of the restructuring of the German economy over the next few years. As part of the transaction Munich Re (MUV2 GY; EUR 335.20) will sell its 40% stake in Allianz Leben to Allianz and will in return receive Allianz's 13.5% stake in HypoVereinsbank (HVM GY; EUR 61.20). At the same time Munich Re launched an offer to buy the remaining 33% of Ergo it does not own yet. A successful bid would improve Munich Re's strategic position in the primary insurance business and could eventually create another financial services giant in Germany. We believe that this development is very favourable for corporate Germany in the long run.

We view ING (INTNC NA; EUR 74) as a very attractive stock at current levels. The group gets 75% of net income from insurance and asset management and only 25% from traditional banking. We do not believe the shares are rated accordingly. With an expected earnings growth of 18% over the next three years and a P/E02 of 12.54x the stock looks very attractively valued. After the recent consolidation of the stock we reiterate our buy rating with a conservative target of EUR 90.

The problems in the telecom equipment sector was underlined by statements of Ericsson (LMEB SS; SEK 56.50) and Nokia (NOK1V FH; EUR 27.21), which announced job cuts of 3300 and 400 jobs respectively. Ericsson is cutting 2100 posts in Sweden and 1200 in the UK, where it ceases its handphone production. This is part of the restructuring package provisioned in 4Q00 and announced in January. Given the low earnings visibility in the sector we do not recommend to place new money in the sector.