Alternative Investments

This is the medicine we recommend for these turbulent times. We currently suggest an allocation of 10% of assets in alternative investments.

US Stocks

There were only 4 occasions when the Fed cut the discount rate 5 consecutive times since 1960. Taking the 19 Feb 1971 as an example, the gains at the 10th day after the rate cut were 2.29%, and the best gains for the first 10 days were 2.29%. The best close occurred on the 10th day, and the worst close was on the 1st day. The percentage change between day 1 and the lowest close during the first 10 days was -1.05%. From the subsequent market observations, the S&P500 were higher in a year out in each occasion, the retracement range from -1% to -10%. Historically, odds remain titled toward higher prices over the next 12-month, particularly with improving liquidity.

For the short term (3-6 mos.), the concerns are as follows:


• note that valuations of the S&P500 Index at each of the 4 dates were lower than what we have now


• Though the inventory glut is being worked out, capacity utilization is at an 8-yr low, there are still plenty of excess capacity out there


• The ratio of corporate debt to GDP remained at the lofty level of 150% compares to a 10-yr average of 141%


• Capex will depend on the profit outlook and the debt level of corporate America, right now it does not look promising on both counts

US Technology Stocks

From a fundamental point of view, there isn't much positive news ahead to encourage further price appreciation from current levels as end-user demand for technology products remain weak and expectations on corporate IT spending continues to be cloudy.

However, from a speculative point of view, long-term investors may be adopting a 'why not' stance and thus, promoting an 'accumulation' phase from a previous 'underweight' position.

In terms of valuations, technology stocks may not be at their cheapest levels but investors have already begun to place bets for an improved 2H01 performance. The NASDAQ Composite index is presently trading at relatively distressed levels of 2.47x price-to-sales and 3.52x price-to-book.

In terms of price movements, the index is again testing the upper range of its near-term consolidation zone and is positioned for a potential upside breakout in price.

Nevertheless, if price does succeed in breaking out on the upside and rallies further, we would still maintain a cautious view and would recommend to take the opportunity to start trimming technology holdings on subsequent price strengths.

To capitalise on the expected near-term up-move in technology stock prices, we have added another preferred eBusiness infrastructure software candidate, BEA Systems (BEAS US, $38.74, CSFB rating: Strong Buy), to our US Recommended Buy list. BEAS reported favourable April-1Q01 results with total revenues that grew 44% sequentially and 67.3% year-on-year to $257.2 million (meeting expectations). EPS of $0.08 beat consensus estimates of $0.07 a share. We like BEAS as we believe the company is well positioned to maintain its track record of healthy revenue growth. With 1Q01 day-sales-outstanding (turnover rate) improving to 72 days from the previous January-4Q00 of 75 days, and cash from operations increasing 6% to $88 million, we highlight BEAS as a well managed company, and an attractive Buy candidate.


Europe

Despite initial concerns after the strong retail sales figures the FED did what markets were expecting and lowered interest rates by 50bp. The fact that they maintained the easing bias was probably as important as the cut itself. We have been supporting the point that lower interest rates will eventually help earnings to recover since quite some time. However, at the current point in time we need to face the fact that we are not quite there yet when it comes to earnings recovery. This applies especially for Europe where the downturn has just started and numbers are expected to become worse before they turn to the better. US Interest rates, which remain the driving force for international equity markets, on the other hand will not fall much further, if at all. Coupled with seasonal factors such as summer holidays, we expect markets to move in a sideways pattern, where intermediate rallies are followed by profit taking. We do not see a significant downside risk as a high level of cash is waiting to be invested. The next trigger for markets will be comments from corporate leaders that they see light at the end of the tunnel. For the time being no such signs are visible yet. We remain cautiously opportunistic but believe that European equities should not be overweighted under a global asset allocation aspect.

Given the low level of interest rates and bottoming US leading indicators we feel that the time has come to become a bit more aggressive on cyclicals. Sectors with a high sensitivity to economic growth such as basic resources, industrials, construction and chemicals have been the leading sectors of the week with gains between 1% and 2.5%. Cylical stocks are not suitable for a buy and hold strategy but due to attractive valuation, limited market cap and economic sensitivity they offer good trading opportunities.

We added three stocks to our recommendation list this week. This has to be seen under a pure European aspect as we continue to remain neutral on Europe in our global asset allocation. The stocks are Pechiney (PEC FP), Syngenta (SYNN SW) and Roche GS (ROG SW).

Pechiney (PEC FP; EUR 66.00) is the world's 4th largest producer of primary aluminium and provided the BHP/Billiton merger goes through the only pure play on this commodity left in Europe. We consider aluminium as one of the most attractive resources. Due to the energy crisis in western US, authorities have asked aluminium producers to close smelters. This accounts for about 9% of the total western production. On the other hand, demand for aluminium is increasing. Characteristics such as its weight and its ability to be recycled easily make aluminium a growing part in cars but also in construction. Pechiney is not exposed to US production as its sites are in Europe, Africa and Australia. Pechiney is a rather smaller player compared to its big competitors such as Alcoa and Alcan. However in terms of profitability Pechiney can be compared with these two players. This let us assume that the valuation discount is not fully justified. Pechiney is currently traded at a P/E01 of 14.2x, while Alcoa is traded at 19.8x. Despite the strong performance over the last few weeks we would buy the stock in any pullback. There is more upside to the aluminium price as well as to Pechiney's valuation. We have set a price target of EUR 75.

Syngenta (SYNN; CHF 90.05) is the leading producer of agrochemicals with a market share of about 18%. The company was formed by the spin-off of the chemical operations of Novartis and AstraZeneca. Its main products are herbicides, fungicides, insecticides and seeds. Despite Syngenta's disappointing 1Q01 sales report the company managed to keep its EBIT and EBITDA margins unchanged. We believe that the sales disappointment was due to seasonal factors as well as problems in the transition of the sales force of the new company and expect an improvement in the second half of the year. Since Syngenta reports in USD and has an excess of cost in CHF and GBP as well as revenue excess in USD it could well be that the company will surprise on the margin side. Our price target is CHF 105.

Roche GS (ROG; CHF 138.75) has suffered from sales disappointments of some of its most important drugs such as Xenical. The stock has lost more than 20% since last December on concerns that its product pipeline would not succeed to produce any major drugs in the short-term. Two weeks ago, Novartis announced the acquisition of 20% of the voting rights for CHF 4.8bln. The company called it an investment with strategic orientation. We believe it could eventually be more than just an investment. The stake in Roche puts Novartis in a favourable position when it comes to industry consolidation. Both companies have said several times that they want to be among the top-players. To get there both need to make acquisitions or go in a merger in the medium term. We do not believe that such a step is imminent but we think it would be an attractive way for both companies to merge. They share the same corporate culture, what would make things much easier. With or without merger Roche is under pressure to perform, which could result in some surprising announcements. We believe that Novartis' acquisition of the stake has given Roche a strong support to the downside. We have a price target of CHF 160, which is still 9% below the December highs.

TotalFina (FP FP; EUR 174.70) reported 1Q01 earnings well above expectations. TotalFina's net income rose 33% to EUR 2.2bln compared to CSFB's forecast of EUR 1.77. The company benefited from an increase in its refining margins by 10% and the weak euro. TotalFina announced that it is likely to increase its share buy back programme from 2% to 3%. The company plans to increase investments by 20% to EUR 9.4bln this year and production by 6% p.a. until 2005. We expect further earnings upgrades for TotalFina and reiterate our buy recommendation with a conservative price target of EUR 185.

Lufthansa (LHA GY; EUR 22.41) reported a 1Q01 loss of EUR 94 million on the back of higher fuel costs and increased spending on internet projects. No reliable forecasts were available as Lufthansa reported quarterly earnings for the first time. Once again wage discussions broke down and pilots went of strike. The management said that the uncertainty about the wage topic made it very difficult to make reliable forecast. At the current point in time we still believe that a solution is possible but admit that our buy call has become a bit more risky. Hence we reiterate that Lufthansa is only suitable for investors who believe in a wage settlement and an improving economy later in the year.

Funds

We have recommended a very focused strategy, Value and Growth. On the value side, we recommend the Putnam Growth and Income (US Value), and ACM Bernstein Global Value fund. For growth, we recommend ACM Global Growth Trends Portfolio.

We would like to re-emphasize the importance of alternative investments in any investor's portfolio. This is the medicine we recommend for these turbulent times. We currently suggest an allocation of 10% of assets in alternative investments.

Alternative investments are portfolios / funds that are not managed like a traditional 'long only' equity or fixed income portfolio. A.I.'s are managed and invested in ways that they provide total returns independent of market moves. The ultimate goal is to have above-average annual returns with low volatility. There are several strategies on how they achieve this. A.I.'s have the ability to go long and short, this is what we call classic hedge funds. Or fund companies may structure a portfolio that capitalizes on pricing discrepancies between underlying values of convertible bonds, to equities - this would be what we call arbitrage funds. Other strategies include market neutral or fund of funds. We are still focused on different strategies namely;Long and Short U.S. - Shaker Heights Class C shares
Fund of funds - Oxford Alternative Strategy
Arbitrage funds - CQS/ CSFB Quant Strategy fund (fixed income)
Event driven/multi managed/merger arbitrage - O'connor Special Situations (UBS)

For Japan, we are wagering that the new administration will do well to investors over the next 12 to 18 months. We are recommending CS Jap Megatrend and MSDW SICAV Japanese Equities.

Our new recommendation today focuses on U.S. small cap, managed by Schroders. We recommend only a small percent of your portfolio to be invested in Schroder's US Smaller Companies Fund (25% maximum exposure in your U.S. Equity allocation.) Why small cap? Relative P/E's are at record lows, and 25% of small cap companies are selling at below 10X trailing earnings. Over the long term, small caps have outperformed large caps. The fund 's strategy is to research and purchase stocks undervalued relative to their growth prospects and with an element of uniqueness not fully appreciated in the share price. The fund also practices strong buy and sell disciplines.