Underweight on Europe in a global asset allocation

US Stocks

According to First Call/Thomson Financial, so far, over 400 companies have said 2Q earnings will be below expectations, this is up more than 7 fold on a y-o-y basis.

The question will be whether investors will pay attention to earnings results (which will be difficult based on the slowing economy), or sort of discount it. Given the recent rally, further gains will come slowly, unless we are assure of an economic turnaround.

In the past four and a half-year, the capacity on computers, communications equipment, & semiconductors has expanded over 4.5 times as opposed to only 14% growth for the non-computers related industrial capacity. Meanwhile, the utilization rate for the technologies dropped from a high of 90% in last July to a low of 74% in April 2001.

This development may very well delay the sector's earnings recovery into next year. What this means is that there is room for disappointments. The very success of innovations, the shortened product cycle and the fight to set the standard in a sector will perhaps impede these companies from achieving consistently higher earnings growth.

As for investments, diversification is in order. Would suggest the following:

Financial
Countrywide Credit Inds. Inc. (CCR $40.55)


US Technology Stocks

Market participants continue to be direction-less but the bias towards positive sentiment appears to be increasing as more investors buy on dips and potentially fewer speculators selling into rallies (as evidenced by the last breakout rally in prices).

Sun Microsystems (SUNW US, $16.63, CSFB rating: Buy), the leading maker of computer servers, depressed the Nasdaq Composite Index last week (by more than 4%) after it unexpectedly warned that its quarterly earnings would fall below analyst expectations due to the widespread weakness in the European market. As a result of its warning, SUNW's shares sank 12.9% the next day to close the week lower at $16.63. The company is currently looking at a harsh reality. In addition to the deteriorating markets in Europe especially in the last 6 to 7 months which negatively affected the company's earnings potential, SUNW is also losing the battle with IBM and EMC. Although SUNW made aggressive pricing cuts, it suffered losses in the Unix server business to IBM (causing huge gross margin declines at SUNW). In the network storage area, SUNW is losing ground to EMC as well and is barely holding the lead in this sector. Although the economy may have bottomed, the expected growth rate ahead will be too slow for SUNW to anticipate a strong rebound in sales and earnings in the near term. SUNW would have to sit around and wait for some time in order for its fortunes to finally become visible again (ie IT managers start spending on the technology infrastructure build-out). Though SUNW is experiencing a difficult macro-driven business spending environment, we believe the company (as well as management) should be able to withstand the current IT spending crisis and be back in the "game" in full strength again, given its proven abilities in execution and strategic vision. We do not recommend to buy the stock for a short-term trading rebound in price. Rather, we suggest long-term strategic technology investors to accumulate the stock on weakness.

We have added Comverse Technology Inc (CMVT US, $59.59, CSFB rating: Buy) to our Trading Buy recommendations list. The stock is recommended for more aggressive technology investors with a higher risk appetite and a shorter investment time horizon. CMVT is a leading provider of software and systems that enable network-based multimedia enhanced communications services. The company has over 350 (260 wireless & 90 wireline) customers and operates in more than 100 countries, including China. The company provides a wide range of wireless data and short messaging services, and other communications services. CMVT's product portfolio helps carriers enhance revenue growth potentials by differentiating their service offerings and potentially reducing subscriber churn rates. CMVT reported January-4Q00 results with revenue that grew 37% year-on-year (yoy) to post record sales of $346.5 million. CSFB expects the company to post favourable April-1Q01 (reporting date: 4-Jun-01) results with sales rising approximately 33% yoy. CMVT has reiterated that they expect to meet or exceed 1Q01 sales and EPS guidance. We highlight CMVT as an attractive short-term trading opportunity (+27% upside potential from the suggested entry price of $59.00 to the recommended profit-taking level of $75.00). However, we also stress to keep a tight stop-loss level at $55.00 to cap potential losses to -7%. In the event of negative sentiment emerging, we expect the potential downside risk to CMVT's stock price to be at around the $45.00 (-22%) level.

Europe

The current focus of European investors remains on earnings and the impact of the continuing slide of the euro. Both factors reflect the deteriorating situation of economic growth in Europe and cause serious concerns about the recent rally since the early April lows. We believe that this rally has gone too far too fast, as there will be no recovery of earnings in the foreseeable future. Despite our belief that 2Q01 will be the earnings trough it looks increasingly likely that expectations for the current and the following two quarters are still too aggressive, especially in the technology and telecom sectors. We are of the opinion that the recent rally in these two sectors was partly justified due to the low valuations in early April. However, given the bleak outlook for the next quarters to come we believe that valuations have again become stretched. The 40% rally of the Euro Technology Index since the April lows to the May highs underlines another concern in our view. Investors remain in constant fear to miss the recovery in the technology-related sectors. Apart from intermediate rallies we do not think that this will happen anytime soon and hence recommend long-term investors to remain very disciplined. Portfolios need to be diversified more than ever. In order to reach the necessary diversification we recommend selling overweight positions in technology-related sectors in any rally and invest the proceeds in other cyclical sectors, such as construction, base material and energy.

Given the increasing need for diversification and hence risk management we suggest equity funds and alternative investments. Alternative investments such as the 'Absolute Europe' or the 'Best international managers' offer the opportunity to invest in different strategies, such as long-short or event driven.

CSFB raised the 2001 WTI crude oil price forecast to USD 26.50/bbl from 23.50/bbl and for 2002 to USD 21/bbl from USD 18.50/bbl. This supports our positive stance on oil stocks and leaves further upside to earnings forecasts. Oil stocks remain the only sector that enjoys earnings upgrades in these troubled times. Our top-pick remains TotalFina (FP FP; EUR 175). We expect the stock to gradually move higher. The stock continues to trade at an EV/EBITDA discount to its major competitors such as Royal Dutch/Shell and BPAmoco, which we believe is not justified given the positive impact of TotalFina's aggressive profitability targets.

Roche (ROG SW; CHF 137) announced 3000 jobs to be cut over the next 2-3 years. Roche is aiming to improve its pharmaceutical operating margin to between 20-25% from about 18% last year. The company further said that sales growth should increase towards the end of the year and also gave a commitment to further strong R&D expenditure. We view Roche's statement as mildly negative as we would have expected a more aggressive way to tackle the current problems of outstanding drugs and the lack of convincing products in the pipeline. We also doubt whether cutting back on the US sales force is the right way to address the problems in the US. However, we believe that Roche's performance will improve in 2H01 and maintain our Buy rating. We see little downside from current levels.

Alcatel (CGE FP; EUR 29.30) and Lucent (LU US; USD 7.99) terminated merger talks as they could not agree on the leadership of the new company. Simultaneously, Alcatel issued a profit warning for Q2 by saying that the company will have to take a EUR 3bnl one-time charge for the write-down of inventories and the loss in value of some investments and asset sales. The company now expects second quarter Telecom operating income above EUR 100 million with a EUR 3bln loss in net income. The company has announced plans to focus on its service provider businesses, including Carrier Networking, Optics and Space. It expects to divest its non-core assets, such as handsets, cable and enterprise business. We believe that the 'Alcatel example' very well underlines the problems this industry is in. Despite the low price and decent valuation we still believe it is too early to revisit the sector.

Vodafone (VOD LN; GBP 1.74) published FY01 results above expectations. Vodafone reported an EBITDA increase of 28% to GBP 7.04bln or 3.75p basic EPS. However, the company had to take a charge of GBP 9.76bln for costs related to its Mannesmann acquisition. The most important point about Vodafone's earnings was the statement that its recent acquisition spree was terminated and that it will now focus on consolidation an internal growth, which would stop the supply of new shares to the market. Despite the decent report Vodafone's shares lost more than 10% for the week and reached a level last seen at the end of 1998. We believe that the share overhang issue will dominate the market in the weeks to come, as the lock-up period for some shareholders will expire. We expect this issue to last for a few weeks and expect the stock to remain under pressure. However, once this technical issue is out of the market we expect the share price to recover. At current levels Vodafone remains an attractive long-term investment and we recommend holding on to the stock.