Diversify your portfolio

US Stocks

First, the good news was Oracle, which said the worst days of the slump might be over. Qwest reiterated that the company would be able to meet earnings estimates. AOL said advertising revenues have stabilized and is on track to meet 2001 targets. Then you have the $12 billion write-off from Nortel Networks. Tellabs (a voice, data, and video network builder) lowered its 2Q sales forecast by more than a third due to weaker demand for its products used to managed traffic over telephone networks.

Stocks remained as a hostage to earnings warnings. Even though they are already down , they kept on going south on any signs of profit warnings. Surely the fall in business activities has been reflected in the share prices.

The CEO of Philips Semiconductors was quoted as saying "Everyone is counting on some recovery in 2H of this year. But it is more based on hope than on firm proof".

The convergence of over-capacity, slow inventory workout, and shrinking global demand formed the "Perfect Storm" in the semiconductor industry.
The situation could be worst than the last contraction in 1985, as the global economy was growing at a clip of 3.7% vs. the more modest estimate of 2.8% for this year.

Looking forward to 1Q next year, due to the base effect of comparing with weak earnings of this year, we could very well see a bounce in earnings. But there is no concrete basis to say that a recovery will take place.

The stock market will probably vacillate between the recession trade and the reflation trade. In terms of investment, a diversified approach is warranted:

Blue Chip- GE, JPM
Low Beta- CCR, RJR
Quality Tech- GLW


Europe

The latest IFO Business Climate Index published this week fell significantly short of expectations. While the market was looking for a number of 91.90 the actual reading of 90.90 reached the lowest level in two years. May 1999 reflected the turning point for the IFO index after the difficult period of the Russian and financial crisis of 1998. Taking into consideration no improvement in the next few months the comparison with 1998 underlines the severity of the current economic downturn. This week's IFO data have again increased the pressure on the ECB to lower interest rates. However, ECB's dilemma is getting bigger with each release of economic data. The CPI figures for the Euro zone hit 3.4% in May, which is the highest level since 1993. Even though the inflation rate is expected to decline later in the year and the ECB might lower interest rates soon the inflation figures make it clear that there will be no aggressive stance possible.

Despite the limited downside potential of interest rates worldwide we expect markets to focus on the FOMC meeting this week. Taking into account the big outperformance of pharmaceuticals over the last month and Merck's profit warning we could see a shift in favour of some selective financials. However, we consider this a trading opportunity rather than a fundamental change. Among the financials we would prefer insurance stocks, which lost more than 15% year-to-date and start to show some good value. ING (INTNC NA; EUR 75.88) and Allianz (ALV GY; EUR 338.15) are our preferred insurance stocks while Deutsche Bank (DBK GY; EUR 88) and BNP (BNP FP; EUR 101.70) appear as the most attractive European banks.

The season of profit warnings continued last week. The most prominent victims were Infineon (IFX GY; EUR 29.95) and BASF (BAS GY; EUR 43.74).

Even though Infineon's profit warning did not hit the market by surprise, its magnitude definitely did. The company said that it would post a 2Q01 loss of EUR 600 million including one-time items, details of which are not available. CSFB's forecast (ex one-time items) was at EUR 125 million, which was similar to consensus views.! Infineon further said that the figure of 400 million handsets sale for the year was very ambitious and would probably be closer to 350 million. The recent profit warnings of semiconductor companies have definitely delayed our cautious hopes of a recovery in this early-indicator industry. Infineon showed a very unlucky hand in communicating the latest shortfall. Around April the company said it sees a recovery of the handset market in summer. In May, Infineon apparently told a few analysts during a lunch presentation that the current quarter will be weak and finally last week's figure was much worse than expected. Infineon's next few quarters are going to be difficult, which could lead the stock even lower as valuations are still some way off the trough valuations of the industry. Trading-oriented investors cannot expect much in the short-term. However, we recommend long-term investors to hold on to the position despite further downside risk. Semiconductor cycles tend to be very volatile and unpredictable. We are confident that the next few quarters will mark the bottom of such a cycle. Infineon is well-positioned in the industry and will hence benefit from the next rebound. However, time is crucial here. Do not expect it to happen in the next 3-6 months. We lower our target price and stop-loss level to EUR 45 and EUR 26 resp. and reiterate our HOLD recommendation.

Given the latest sell-off in technology some of our price targets and stop-loss levels need to be adjusted. For details please refer to our recommendation list. Since February we reiterated several times that we stick to our Hold recommendation and advised not to buy these stocks. However, despite the enormous difficulties the sector is in, we remain convinced that the strong names will emerge stronger from the current downturn. As valuations reach more attractive levels we continue to recommend holding on to our technology stocks with a view for a 2002 recovery, provided diversification in other sectors is granted.

BASF's profit warning and the increasing pace of the slowdown in Europe has caused us to remove Rhodia (RHA FP; EUR 12.15) from our recommendation list. Despite attractive valuation we feel that the share price has only little recovery potential until prices for basic material (esp. oil) start declining and the economy shows credible signs of stabilisation. We do not expect this to happen before the end of the year.