Investments via equity funds

We strongly advocate balanced investments with a focus on quality rather than a bet on the most battered stocks or sectors. Investments via equity funds are the appropriate way as stock selection in the early phase of a recovery will be very difficult.

US Stocks

A year and 3,328 points on the NASDAQ ago, in March 2000, when the equity markets were on a one-way ride. Stocks that were incapable of going down, that was the New Economy. Now, everyday brings more earnings warnings and another historical stock price low. The technology "blue chips" suddenly find that their double or triple digit revenue growth have dried up and that the tyranny of the business cycle is still with us. In the end, it is a question of saturated demand, excess inventories, and a downturn.

As mentioned in the last weekly, the capacity growth was mainly concentrated in the technology area. The traditional durable and non-durable manufacturing have seen both their capacity growth and utilization rate decline in 2000. Therefore, the excess capacity and inventory workout in the Old Economy may not be as bad as the New one. To make things worse, the Old Economy might decide to hold off from purchasing equipment like networking and computers until their own downturn is over, so the tech industry would likely take longer to recover than the traditional industries.

The service sectors like outsourcing, food & drug stores and healthcare management should experience moderation in growth as non-tech manufacturing and construction activities slow, but should offer defensive quality in the current market condition.

Nonetheless, a recession will prevent business to pick up anytime soon, particularly when technology is responsible for two-fifths of the GDP growth. If that is the case, and the economy turns for the worst, diehard investors will finally loose faith, and then we will find ourselves in for a longer than expected bear market.

US Technology Stocks

On a week-on-week basis, the NASDAQ Composite index continued to trade south-bound and ended the week -6.5% lower at 1720. For the week ahead, we expect prices to trade side-ways (at best) due to the lack of positive news in the near-term. Sentiment will be mixed ahead as investors await leading companies like Lam Research Corp (LRCX US, $22.0625, CSFB rating: Buy), Yahoo Inc (YHOO US, $14.8125, CSFB rating: Hold), and Juniper Networks Inc (JNPR US, $33.80, CSFB rating: Buy) to report earnings during the week. Attention will then be focused on their forward-looking expectations and earnings guidance.

Maintain Hold on the eBusiness Software Applications segment. Last week, six software companies warned that they will miss earnings estimates for the quarter. As client companies temporarily suspend software spending, due to the continued uncertain economic environment in the US, software application vendors have become the latest victims of the earnings slowdown scenario. In terms of falling short of expectations, i2 Technologies (ITWO US, $16.9375, CSFB rating: Buy) will miss estimates by 1.4%, Commerce One Inc (CMRC US, $6.2000, CSFB rating: Buy) by 18%, E.piphany Inc (EPNY US, $7.9688, CSFB rating: Buy) by 24%, Documentum Inc (DCTM US, $9.1250, CSFB rating: Hold) by 26%, Broadvision Inc (BVSN US, $2.8438, CSFB rating: Hold) by 29%, and Ariba Inc (ARBA US, $4.8438, CSFB rating: Buy) by 51%.

Though the shortfall was expected by the market, the magnitude of the group miss was bigger than anticipated. We expect sentiment towards the segment to remain subdued and stock prices to trade in consolidation until more guidance is received from the management as they report results later in the month. Nevertheless, while spending recovery scenarios are difficult to envisage at the present time, we continue to have positive expectations for the segment in the long-term as we remain believers in the group's value propositions (enhancing revenue reach and suppressing cost functions) and the subsequent benefits to earnings growth potentials. As such, we maintain our Hold recommendation on ITWO and CMRC.


Europe

This week's economic data out of Europe, such as manufacturing orders in Germany, industrial production in the UK and consumer confidence in France pointed to Europe being affected by the US slowdown. This week's ECB meeting will be very important for European equity markets. We expect the ECB to reduce interest rates by 25bp to 4.5% on Wednesday. Everything less than that would be a disappointment to markets and treated accordingly.

The string of profit warnings did intensify further last week. The conclusion of the announcements of the likes as Ariba, Agilent, Autonomy, Sycamore Networks and Tellabs is that corporate investment spending in technology has declined to a much larger extent than previously expected. Analysts' forecasts do not expect this trend to revert before 4Q01. Consequently we expect the next few weeks of earnings announcements to be very volatile, in particular for technology companies as European managers will use this opportunity to give guidance for Q2.

Though improving the European communication culture is different from the US as Europeans tend to use official occasions to make statements rather than intermediate announcements. However, the tone will be negative in trend blaming slow demand for the low earnings visibility for the rest of year. Even though this might be priced to a large extent we believe further volatility will cause prices to decline a bit more over the next few weeks.

Despite the earnings uncertainty we believe that the rapid decline of interest rates will increasingly catch the attention of investors who are still very much focused on bad news.

Interest rates in the US and Europe have still room to fall despite the aggressive cut of 150bp in US interest rates this year. With the negative news being increasingly reflected in the equity prices we expect investors to shift their focus on valuations soon.

The fact that we never manage to call the perfect bottom and valuations are much more reasonable causes us to turn more positive on equities with an investment horizon of 12-24 months. We strongly advocate balanced investments with a focus on quality rather than a bet on the most battered stocks or sectors. Investments via equity funds are the appropriate way as stock selection in the early phase of a recovery will be very difficult.

The most controversial topic of last week was the re-emerging topic of vendor financing in the telecom equipment industry. Nokia announced a series of new contracts to supply the 3G networks for companies such as C & W Optus, Hutchison, France Telecom's affiliates Orange and Mobilcom and Wind worth approx. USD 3bln. While this would be good news, the market focused on the high amount of vendor financing Nokia had to accept to acquire France Telecom and Hutchison. Nokia agreed to supply USD 2.6bln in bridge loans to France Telecom and Hutchison. This loan clearly exceeds the value the USD 2bln orders to provide the UMTS network. The fact that Ericsson and Alcatel entered into similar agreements with France Telecom underlines how desperate telecom operators are to get cash. While vendor financing does not necessarily have to be negative it increases the business risk equipment companies have to take in order to receive orders. We remain cautious on the sector even though these orders are positive for the three companies in the long-term.

The profit warnings of software companies such as Ariba and Autonomy caused European software companies to post big losses. We decided to take loss on Cap Gemini. The rapid decline of software spending in the US might cause earnings revisions for Cap Gemini, which leaves the stock at high valuation compared to its US competitors. Should the downward revisions come through the current fair value for the stock would be in the area of EUR 100-110. We were stopped out of Schneider Electric (SU FP; EUR 65.90) with a loss of 10%. Despite Schneider's attractive valuation we believe that its cyclical appeal might take longer to materialise with the recovery in the US to take longer and Europe to slow down.

Carrefour (CA FP; EUR 61.60) is scheduled to report 1Q01 sales on April 11. We do not believe that this report will provide tangible evidence of a recovery in Carrefour's sales. The market will be looking for the impact of the foot and mouth disease in Europe and the problems in emerging markets such as China and Argentina. Despite the short-term difficulties Carrefour faces we believe that the worst is over and newsflow will start to improve in the months ahead. We would use weakness related to the Q1 sales report to buy the stock for medium term investors.

Volumes are likely to be low ahead of the long Easter weekend. This could cause volatility to increase in the following days. The season of earnings reports will take off next week.