Continue to remain cautious on technology issues

US Stocks

The 5-yr average for the retail and food services sales ex. autos & parts is 0.46%. Standard and Poor's credit rating service has downgraded its S&P retail group due to a bleak outlook for credit quality. S&P does not expect this activity to abate in the 2H based on negative outlooks for 35% of rated retail companies.

For the first time in its 20-yr history, the 401(k) retirement savings plan lost money last year, even adjusted for new contributions. The average account lost over 10%. Moreover, declining stock price has also hurt employee's stock options. On top of a higher unemployment, big ticket items like auto sales and housing showed no signs of slowing, 1-yr adjustable mortgage rate hit a low last Monday at 5.71%.

According to a study by Challenger, Gray & Christmas, an outplacement firm revealed that US companies announced 124,852 planned job cuts in June. This is a hefty 56% increase relative to May's number of 80,140. The cuts in the industrial sector were led by -

Telecom -27,446
Industrial goods - 22,698
Industrial services - 11,463

Corporate America is focusing on cost cutting to prop up earnings; initially it was capital expenditure, now we are seeing it in labor, and soon performance bonuses. If the credit numbers stopped growing from June to July, then we will know the consumer has stopped buying.

First Call reports that of the 1,000 companies that have given indicators of what their Q2 will be, 68% say they will miss their earnings estimates.

The 'tech' earnings recession has become a more broad-based earnings slowdown. In times when capital gains are harder to come by, investments should be focusing on:

A) companies with diversified businesses like General Electric Co. (GE $56) and Loews Corp. (LTR $58)

B) companies that have already announced substantial charges like Corning Inc. (GLW $14.60) and JP Morgan (JPM $42.60)

C) companies with more reliable earnings stream like Pfizer Inc. (PFE $38.50) and RJ Reynolds (RJR $50.30)

D) Natural resources company like Burlington Resources Inc. (BR $39) and E) Amgen (AMGN $55.70) which looks very attractive at current levels despite FDA's delay in approving its update version of its best-selling drug, Epogen.



US Technology

On a week-on-week basis, the NASDAQ Composite Index rose 3.9% (closed at 2084) to rebound from the previous week's bearish decline.

Remain cautious on technology stocks. While the Bear continues to rule investment sentiment towards technology issues, US equity traders have started to take bets in the opposite direction (short-term contra trend trading) so as to capitalise on unanticipated good news from companies pre-announcing better than expected results. With visibility on end-demand still clouded and the potential recovery to future earnings growth remaining uncertain, our cautious stance on technology investments is unchanged. We recommend investors to continue taking a conservative approach to investing in technology issues in the near-term and remain patient during the reporting season to allow volatile prices (and sentiment) to settle before accumulating for long-term (1 to 3 years) performances. Looking ahead into the week, we believe the NASDAQ Composite Index has the potential to weaken back towards 1970. The market remains undecided as to when technology companies will post improved earnings growth (from 2H01, to 1H02, to 2H02) and as such, investment confidence in US technology stocks remain fragile and highly selective.

Cautious on Lucent Technologies (LU US, $7.33, CSFB rating: Hold). We continue to recommend investors NOT to invest fresh money into the stock. For investors who still own the issue, we recommend to look to SELL a portion of their holdings on any price strength so as to reduce exposure to the company. Though LU's stock valuation is undemanding, we believe the company specific risk is still high. LU faces a steep uphill task of securing cash to fund operating activities and service debt obligations. With the continued downturn in the US economy and the current restrictive IT spending regime, LU will be hard pressed in its divesture exercise of non-core business assets. Furthermore, the company faces the growing risk of securing payments from its customer financing activities (and receivables). LU's stock has degenerated from a quality data networking play to a distressed restructuring theme. We prefer to manage the large risk of uncertainty by avoiding the issue completely, or by taking the loss on a failed investment by selling into any price rebound. Remaining cautious on LU.

Europe

Looking at the performances of the different sub-indices of the European STOXX Index over the last month offers an interesting picture. The European STOXX Index lost 3.27% in this period. While the European Technology and Energy Indices lost 15% and 8% respectively there were 8 out of 18 sub-indices that posted a positive performance. Among those there were 3 cyclical sectors out the first 4, such as Auto, Basic Material and Consumer Non-Cyclicals. Apart from those, Retailers and Insurance stocks were among the top performing sectors as well. The point to note here is that most of these sectors show a typical bottoming behaviour (which can sometimes be volatile). Indeed, this gives us the confidence that these sectors are in relatively good shape. We might assume that the interest rate medicine is working, and, going forward, we look for more signs that the earnings cycle is nearing a trough, which is a reason for some cautious optimism. This does not, however, apply to the technology sector, where we see no earnings recovery in sight despite some hopes that things might stop getting worse towards the end of the year.

Consequently, we stick to our positive view on selected cyclicals, such as Pechiney, Lafarge and Syngenta. We will consider adding some more when we believe the timing is right. Since European economies are at an early stage of the downturn it is crucial to focus on the US exposure and/or special situations. We recommend complementing these stocks with some steady earnings generators such as insurance stocks like ING (INGA NA; EUR 37.65) and Allianz (ALV GY; EUR 321) or healthcare stocks (though not cheap) like Aventis (AVE FP; EUR 88.60), GlaxoSmithkline (GSK LN; GBP 20.24) or Roche (ROG SW; CHF 132.50). We believe this offers a reasonable risk/reward balance in a portfolio. We would remain cautious on the technology sector and additions should only be made after the earnings announcements and with at strict 12-18 months view. Investors with big overweight positions in technology should broaden their sector exposure by adopting the cyclical/steady earnings generators approach.

In a global approach, however, we continue to underweight Europe. We believe that some of the US non-technology sectors offer more upside due to earlier signs of an economic recovery.

STMicroelectronics (STM FP; EUR 35.30) reported 2Q01 earnings ahead of schedule. The company announced a 54% decline in net income to EUR 155 million of USD 0.17 per share. Gross margins stood at 38%. This was in line with expectations. However, the high level of one-off charges (USD 311 million) for factories and cancelled orders surprised the market and underlines the rapid deterioration in the telecom industry. The management tried to give an optimistic outlook by saying that the industry is expected to bottom out in Q3 and show an improvement in Q4. STM expects Q3 to post a sequential decline in sales of 10-15% and gross margins to be between 32% and 36%. We remain cautious on STM's outlook as it could well be too optimistic. The fact that figures in Q3 will be worse underlines the difficult situation in the industry. We continue to rate the stock 'Hold' as we are convinced of STM's strong position in the industry and the ability to emerge stronger from the current downturn.

Nokia (NOK1V FH; EUR 21.43) remained under pressure last week. The company stopped equipment sales to Turkish operator Telsim due to failure to pay USD 240 million in financing. According to media news Nokia has USD 719 million in vendor financing outstanding to Telsim. This, earnings reductions and a cautious stance ahead of the earnings report caused the stock to lose another 7% for the week. The market is positioning for bad news out of Nokia, which makes sense. The company said on June 12, 2001 that it was unable to give guidance until the earnings report. Given all the bad news from the sector we do not expect a bullish statement from Nokia, which might cause further pressure on the stock.

Carrefour (CA FP; EUR 62.15) reported an increase of 8.2% in Q2 sales to EUR 19.2bln. This is in line with expectations. Carrefour reiterated its earlier guidance of EUR 70bln in sales for 2001 despite the expected 2H01 slowdown in Brasil (4% of sales). We expect sales to turn positive relative to the market in Q3 and continue to believe that Carrefour is under-valued. Hence we believe that Carrefour fits neatly in our strategy of a combination of cyclials and value stocks.

This week will be extremely rich in terms of earnings reports in the USA as well as in Europe. While Tuesday marks the highlight in the US it will be Thursday in Europe. We expect markets to focus on the outlook statements rather than on the 2Q01 figures as most companies have issued profit warnings in the past weeks. Among the companies scheduled to report this week are:

Date consensus EPS

Philips 17.7.01 EUR 0.18
Nokia 19.7.01 EUR 0.15-0.17
SAP 19.7.01 EUR0.42 (CSFB)
Ericsson 20.7.01 SEK-0.41(CSFB)
DaimlerChrysler 20.7.01 EUR 0.23