Underweight on Europe in a global asset allocation (page 1 of 3)

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.