Diversify into sectors with better earnings visibility

US Stocks

According to Allen Sinai, chief global economist for PDE (Primark Decision Economics), the United States is going through an upside-down type of slowdown. Housing and personal spending have so far held up well unlike in other downturns. What is dragging the economy down is capital spending from the business sector. Since they react less vigorously to lower rates, there is no guarantee that interest rates alone will work in the traditional way. Expectation of future sales and earnings will determine corporate expenditures, but right now, they do not have much confidence in the economy after it turned the weakest performance in eight years during the 2Q.

Equities have suffered sizable loses during the 2Q earnings season, with widespread disappointing results. With companies in many sectors that cannot provide forward guidance of any kind, all the more reasons to diversify into sectors with relatively better earnings visibility, as I have reiterated through out last week's morning calls:

Tobacco - R.J. Reynolds (RJR $50.25), the stock is down 19% from its recent high. With a dividend yield of over 7%, 10x '02 estimates, the stock is cheap even accounting for the recurring litigation

Biotech - Amgen Inc. (AMGN $60.82), recent weakness stemmed from the delayed approval of its updated version of its best selling drug Epogen over labeling issues. Earnings guidance of low double-digit '01 EPS growth assumes no contributions from US Aranesp sales. The European Commission has already approved the drug; US approval within the year will provide the upside

Energy - Burlington Resources Inc. (BR $43.28), though up 10% since the recommendation, target remain at $49. Inventory build up seems to be peaking with OPEC reducing output. Along with non-OPEC Mexico they have close to 45% of the world's production, they have agreed to stabilize current oil prices. Current output reduction may very well bring about higher prices in the coming winter

Holding Co. - Loews Corp. (LTR $53), trading at a slightly over 6x prospective earnings, the stock is selling at a 41% discount to its value of $90.00 per shares (using sum-of-parts calculation)

Aerospace - Boeing Co. (BA $58), currently locked in a battle with Lockheed Martin Corp. to win a Pentagon contract which will subsequently worth $600 billion in the next 3 decades (including foreign sales & maintenance contracts). BA is touting its low cost and reliability for the joint strike fighter (to be used by the 3 US military services), and the announcement will be made in October. The Pentagon may decide to split the contract among several contractors

Honorary mentions - at current levels the following stocks offer excellent long-term investments:

General Electric (GE $44.65)
JP Morgan Chase (JPM $44.21)
Pfizer Inc. (PFE $39.84)
Countrywide Credit Industries Inc. (CCR $42.74)

And for stocks that offer good value even though they may not be at the bottom of their earnings cycle:

WorldCom (WCOM $15.21)
Corning Inc. (GLW $16.02)

US Technology

Cautious on technology stocks. On a week-on-week basis, the NASDAQ Composite Index traded flat (closing unchanged at 2029) on volatile sentiment throughout the week.

With only a handful of technology companies reporting results this week, we believe investors will be looking outside the technology arena for trading directions for the week. We expect trading activity to be volatile and directionless as short-term investors react to US economic data releases during the week.

Cautious on JDS Uniphase (JDSU US, $8.55, CSFB rating: Hold, CSPB MG V Recommendation: Hold). Last week, JDSU reported continued weak quarterly results. June 4Q01 revenues fell 35% sequentially and 6% year-on-year to $60.1 million (meeting reduced estimates) on persistent order cancellations and order push-outs. Excluding one-time charges, JDSU posted EPS of $0.02 which was slightly below consensus estimates of $0.03 a share.

We are cautious on JDSU in the short-term as demand for fiber optic components continue to stay weak but at the same time, we are encouraged by the company's efforts in reorganising it's cost structure. JDSU has scheduled to layoff a total of 16,000 staff and shut down an aggregate of 2 million square feet (or 30% of total space) of manufacturing space. JDSU's restructuring initiatives (Global Realignment Program) is expected to cost $950 million (one-time expense) while saving $700 million annually. JDSU ended the quarter with cash of up to $1.8 billion (cash, cash equivalents and short-term investments) and no debt.

With the pick up in demand still an uncertain event for the company, we are cautious on JDSU in the short-term and maintain our Hold recommendation on the stock. In terms of price, we believe the company's stock price has yet to find a floor and as such, we do not recommend investors to commit "new money" into the stock yet. Maintain Hold on JDSU.

JDSU Valuations: (at $8.55)
Price-to-Earnings 142.5x
Price-to-Sales: 2.48x
Price-to-Book: 0.18x
(source: CSFB, Bloomberg)

Europe

European markets tested new lows last week and reached a level last seen 21 months ago. In the UK markets reached a new 33 months low. Since the peak on May 22, 2001 the Euro STOXX 50 has lost about 14%, with the technology index losing almost 40%. With all the bad news out so far and the earnings season of the financials starting in early August we expect European markets to try to find a bottom in the weeks to come. However, due to a lack of good news we see no reason to rush back to the market right now as equity investors are not convinced enough to start buying.

ABB's and Invensys massive earnings disappointments acted as a wake-up call to many investors. After the earnings disappointments in the tech sector the economic downturn in Europe is spilling over to the manufacturing industry. The fact that the German business confidence Index IFO fell to a level last seen five years ago underlines these concerns. While we agree that earnings reports of cyclical companies have potential to disappoint, we would advise not to adopt ABB's shortfall as a proxy to the whole industry. ABB's problems go beyond economic slowdown and high Germany exposure. The company's restructuring program has failed to convince investors so far. After missing earnings forecasts by a wide margin ABB's stock price fell 22% for the week.

With no sign of an economic turnaround in Europe in sight cyclical stocks could be in for a volatile quarter. Nevertheless, we feel confident with our exposure to Pechiney (PEC FP), Lafarge (LG FP) and Syngenta (SYNN VX) with an investment horizon of 2-3 quarters. Most of the bad news should be in the price after last week's declines. Historically, the time to buy cyclical stocks has been the point when earnings were the worst. We are convinced it will not be different this time and regard the coming volatility as buying opportunities.

GlaxoSmithkline (GSK LN; GBP 20.20) reported earnings precisely in line with estimates. Sales increased by 13% and EPS by 18% to 20 pence. However, the quality of earnings is somewhat higher than anticipated as the outcome in pharmaceuticals and trading was ahead of expectations. The company said that it would meet its targets for 2001. We feel confident with GlaxoSmithkline as a long-term investment with solid and stable sales and earnings growth.

The good news in the technology sector was that the two bellwether stocks, Siemens and Alcatel, managed to meet the lowered earnings estimates. The bad news is that the outlook for the rest of the year remains very difficult (esp. Q3!). The results are also a reflection of the disastrous situation the network industry is in. Siemens needs to take a one-time charge of EUR 790 million for the telecom unit ICN while Alcatel needs to make write-offs of EUR 3.2 bln for investments and inventories. Alcatel's 2Q loss of EUR 3.1bln is twice as high as its record profit in 2000! Both companies announced management changes and expect the industry to stabilise in Q401. Given the cautious comments on the European telecom industry by both companies and their high exposure to this region we expect these stocks to lag the US counterparts in an eventual recovery. Despite attractive price levels and most likely the worst news being out we do not think that these stocks are completely out of the woods yet and advise caution.

Lafarge (LG FP; EUR 97.95) reported 6 months sales figures. We believe that this is a strong set of numbers and bolds well for the earnings release on September 4, 2001. Sales declined by 1.4% to EUR 5.578bln, which was ahead of our estimates. Like-for-like sales grew by 1.9%. In all divisions except gypsum products Lafarge posted strong sales figures. The stock declined this week based on the CEO's remarks of Germany being the 'dark spot'. We think that the market's reaction was overdone and recommend buying the stock in any weakness. Our price target remains at EUR 125.

Pechiney (PEC FP; EUR 56.0) reported 2Q01 operating profit of EUR 142 million, which was at the lower end of expectations. We are slightly disappointed about the mix of the results. The aluminium results disappointed due to the decline in aluminium prices in Q2 while the packaging unit surprised. However, we remain confident that aluminium remains the most attractive metal due to its unique supply-demand characteristics. The global economic weakness could cause increased volatility in Pechiney in the weeks to come. With global economic data likely to turn better in the months to come we remain buyers of the stock with a price target of EUR 75.

Among companies to report are:

July 30, 2001 Cap Gemini
July 31, 2001 Celanese
August 1, 2001 Deutsche Bank
August 2, 2001 Aventis
August 2, 2001 Royal Dutch
August 3, 2001 Unilever