Value and growth style investing

US Stocks

The monetarists led by the Nobel laureate Milton Friedman believe that the changes in the stock of money exerted a powerful influence on the GDP, as well as on the level of prices. Since we live in a money economy, one can see how the flow of money affects the stock market movements.

The following is an observation of the Federal Reserve's policies on the banking system as a whole in relation to their loans and investments on one hand, and their deposits and liabilities on the other. Money supply may be considered as a measure of liquidity, it also depends on how much money supply has been created by loans, because all bank loans have to be paid off which reduces the money supply. A measure of liquidity is to take the bank deposits and deduct bank loans. The resulting series give a fair idea of how liquid the economy is and can be related to a number of economic series in terms of identifying stock market movements.

The Deposit/Loan ratio measures the health of the economy by the balance sheet position of its businesses. How efficiently capital was being employed, the aim is for the economy to come up with a healthy balance sheet while generating output that might well be free of excess inventory, which is non-recurring and even self-reversing. Thus it can also serve as an indicator for corporate earnings (with a 6-mo to 12-mo time lag).

In this study, the following factors were used: period: 1990 - 2000, S&P500 index, liquidity, Deposit/Loan ratio, quarterly corporate profits, Money growth M1

The bull run of the S&P500 started in 1992, when the following conditions were present:

- Bank liquidity were building up in the early '90s
- The extra cash not absorbed by the economy
- The D/L ratio was moving above the 1.2 level in '91
- Indicating corporate profit was growing
- By the beginning of '92, M1 hit double digit growth rate, and lasted until the end of 1993

The observations are as follow:
- Bank liquidity came from below $200 billion in 1973 to a peak of slightly over $500 billion in the month of Dec-92 coinciding with the D/L ratio

- Corporate profit was below $100 billon in early 1973, peaking at $832 billion in June-2000

- In 1994, liquidity started to decline but managed to stay near the $300 billion level. Profit growth in 1994 remained strong with D/L ratio above 1.1 level, but M1 growth started to trend down due to increasing Fed Fund rate, and the S&P500 ended the year lower

- 1995 & 1996 when lower and stable interest rates offset lower liquidity as loan demand picked up, and negative M1 growth rates. Furthermore, D/L ratio managed to stay near the 1.1 level indicating continued earnings growth

- The Fed fund rate was higher at the beginning of 1997,but the negative money growth rate began to moderate, and there was sustainable earnings growth as the D/L ratio stayed above the 1.06 level

- During 1998, liquidity continued to decline as loans picked up, the D/L ratio started to show weakness as it fell towards the 1.03 level indicating declining earnings. But M1 growth returned to positive growth, and the Asian crisis and LTCM brought relief in the form of aggressive Fed Fund rate cuts

- In 1999, liquidity continued to drop, especially after the Fed instituted its tightening policy in June, even as loan demand started to taper off. M1 growth started to shrink again. Despite the D/L ratio declining towards the 1 level, earnings were supported by Y2K related purchases

- Liquidity turned negative in the beginning of 2000 and for the first time since 1973, the D/L ratio fell below 1. It has become apparent that the incremental growth in profits was becoming more difficult. Corporate America has resorted to borrowing to boost growth with mixed results. At the beginning they managed to show positive growth, but once the M1 growth rate went into negative territory, a result from the 175 basis points increase that peaked in June, the economy stalled and earnings took an express train south

Looking at the latest data, deposits are showing signs of growth. Loan demand is coming off, and the decline in liquidity is stabilizing. More important, the D/L ratio has moved back up to the 1 level. M1 growth also has shown moderation in its decline, and interest rates are 150 basis points lower. As data from the table has shown a sell signal on Jan-00, perhaps now is the time to buy.

So far, the NASDAQ has been leading the charge, gaining more than 10% since 2 April 01, and the S&P 500 is lagging with only 3.3%. I think this recovery will be more on earnings rather than growth. Overall, the 'old economy" should take the lead. Please consider our existing buy lists for the buy candidates.

US Technology Stocks

With a 14% (sequential weekly performance) rally on the NASDAQ Composite Index last week, the question that lies ahead then will be the sustainability of the apparent rebound. We do not believe the upside rally will be sustainable over the near-term as the demand fundamentals do not support the case. On the contrary, we expect prices to weaken further from continued profit-taking as investors turn conservative (again) due to a host of "blue chip" technology companies that are scheduled to report earnings for the week. Thus, we remain cautious and advocate conservatism in accumulating stocks at this stage.

Remain positive on Juniper Networks (JNPR US, $48.38, CSFB rating: Buy) in the long-term. JNPR announced 1Q01 results that met expectations with EPS at $0.25 per share. Revenues grew 12% sequentially and 420% year-on-year (yoy), to $332.1 million. Nevertheless, the company's management revised down its earnings expectations as telecommunications service providers have temporarily scaled back IT spending budgets. JNPR expects 2Q01 revenue to be flat and 3Q01 revenue to be sequentially lower due to seasonal

factors. CSFB expects FY2001 revenue estimates to grow about 95% yoy and EPS of $0.97 a share. We continue to like JNPR as the company continues to execute in a near flawless manner. Furthermore, we believe the company is well positioned to grow by continuing to add new customers (thus also increasing customer diversification) and expanding into new market regions (ie Asia). However, we do not recommend to buy JNPR at the current time as we expect the overall market sentiment to remain weak over the new few weeks and could potentially drag down JNPR's stock price as well.

Europe

Starting this week the market will get to know the full truth about 1Q01 weakness that literally attacked companies overnight. The magnitude of the sell-off since early February let us assume that the market priced in the worst for the first quarter. Under this perspective the earnings season could act as a relief to the market.

However, what is about Q2? It is hard to imagine that companies could tell anything positive and hence we consider the risk that companies will try to dampen expectations for Q2 as quite high. Cisco and Philips delivered the first evidences yesterday and today that this assumption is quite likely. So, what is the latest rally all about? In fact, there was no particular good news that could be regarded as a trigger for the sharp rally in some stocks. It could well be a rally that proves to be premature and hence the coming earnings season might act as a trigger for profit taking.

However, even though the latest rally may not be sustainable it contains an important message. Firstly, investors are prepared to come back to the market if the price is right and secondly, investors seem to take a somewhat relaxed stance towards bad news, which might indicate that the bad news is priced and hence the worst might be over.

Ahead of the earnings reports we do not change our cautiously optimistic stance yet. Assuming that the second quarter might be the trough quarter we recommend using weakness related to the upcoming earnings reports over the next few weeks to start building up long-term positions. The high cash level of investors is waiting to come back to the market once news start to improve.

The above scenario applies for Carrefour (CA FP; EUR 63.50). Carrefour published 1Q01 sales. After recent events such as food & mouth disease in Europe and problems in Argentina and Brazil the consensus took a defensive stance ahead of the results. 1Q01 sales increased by 9.6%, mainly boosted by acquisitions. In France, which accounts for 50% of group sales hypermarket sales increased by 0.7% and in Spain (20% of group sales) they declined by 3%.

Even though these figures were not exciting they were slightly ahead of CSFB's forecast. The more positive point can be seen in the improving trend of sales, which underlines that the company is making progress in bringing customers back to stores after the negative perception of the Promodes integration. The market reacted positively on the somewhat disappointing head-line figures, which tells us that the worst for Carrefour is over and that investors should start buying the stock with a 12-month target of EUR 80. We expect the newsflow to improve in the coming quarters.

Technology and telecom stocks posted nice gains, driven by semiconductors and a somewhat reduced pressure on telecom loans on expectations of lower interest rates and several broker upgrades. We retain our cautious stance on telecom companies even though headline valuations might look attractive and stocks seem to have formed a base. We remain concerned about Moody's statement that five of Europe's former phone monopolies (BT, FTE, DTE, KPN and Sonera) may face further credit rating cuts. Stock picking within the sector has to be very selective.

Chip stocks had a very good run based on several broker upgrades. Among the technology sub-sectors we consider the semiconductor stocks to be the first to rebound although it might still be early days and risky to expect a substantial recovery. It is admittedly fragile to call a bottom for these stocks at current levels but Q2 might well be the trough quarter for the sector. We expect earnings of these companies to be very weak for Q1 and outlook to be clouded. However, we would use weakness based on the above scenario to upgrade selected semiconductor stocks. We believe that the risks to DRAM related chip stocks such, as Infineon (IFX GY; EUR 47.06) is currently lower than the risks to the communication sector.

Philips (PHIL NA; EUR 32.30) opened the string of technology earnings today. Philips posted earnings per share (EPS) of EUR 0.08 compared to a consensus of EUR 0.21. Philips will take an extraordinary charge of EUR 350 million in Q2 and produce a loss for the quarter. In order to respond to the sharp decline in demand, Philips will lay-off 6000-7000 staff. Components, Consumer electronics and to a lesser extent Semiconductors were weaker than expected while the other units were in line with expectations. Even though the market was prepared for a weak report we believe that this is well above the threshold. Earnings forecasts will be revised downwards in the coming days. We continue to rate the stock 'Hold' for the time being. The massive shortfall underlines our scenario that a substantial recovery will take more time to unfold than previously expected.

Funds

We continue to stress the importance of understanding the two styles of investing, namely value and growth. Value investing could be defined as investing in companies with high cash flow, low P/E, low p/e/g, low p/b ratios, among other things. Growth investing on the other hand is what most investors are accustomed to, buying companies selling for high multiples (p/e, p/e/g, p/b) due to their forecasted growth rates, top line and bottom line. Going forward, an approach that covers both styles, and an active management will be the recipe of success in investing in the equity markets.

We stress both styles because historically style rotation out of value and into growth, and vice versa have occurred with a level of unpredictability (at best the style rotation oscillates every 3 to 4 years), that it is only possible to own both asset classes at any given time. After owning both types of assets, should investors look to start a position or increase their position in sector funds such as tech, biotech, etc. Get the fundamentals of investing right first.

We favor two funds today as a core holding. Purchase the first 25% of allocated equity capital in Putnam Income and Growth for value style investing, and ACM Global Growth Trends for growth style investing.

Putnam Growth and Income (U.S. Value Equity) Fund (PUTGRII OS) applies Putnam's distinctive value strategy, searching for qualities of "cheapness and change" in large and midsize companies. Fund's management looks for attractively priced, mostly dividend-paying stocks of companies that are temporarily out of the market's favor but are expected to recover thanks to positive internal change. Holdings are diversified across a broad array of industries. The domestic (U.S.) version of the fund has been around since 1957. Offshore investors invest through a feeder fund structure. Purchases and redemptions are done daily. Historical Performance: Average Annual Total Return: YTD -1.68%, 2000 +4.7%, 1999 -3.1%.

Alliance Capital (ACM Funds) was founded in 1962 as the investment management department of Donaldson, Lufkin & Jenrette, Alliance Capital today is a leading global investment advisor supervising client accounts with assets as of December 31, 2000 totalling approximately $454 billion in over 30 offices worldwide. Alliance Capital provides investment management services to institutional and individual investors through a broad line of domestic and international products covering the investment spectrum.

ACM uses proprietary research to select investment themes and stocks, putting a premium on investment research. ACM Global Growth Trends Portfolio (ALLGLAI LX) focuses stock selection based on industry research, not geographic. The selection is research driven through in house research focusing on the best growth companies in the best growth industries. The 6 sectors that the fund invests in are: Communications and Technology, Consumer Growth, Healthcare, Energy, Infrastructure, and Financial Services. Six sector fund managers with an average of 15 years experience manage the fund. 63% of the funds are invested in North America, 20% in Europe and the balance in Asia, Japan, South America and cash. Historical Performance: Average Annual Total Return: YTD -6.38%, 2000 -0.6%, 1999 +43.8%.