Consolidation still in progress for the US technology sector

US Stocks

In the previous weeklies, we had mentioned the following -


• Challenger report (out placement)

• Non-durable manufacturing down

According to the Challenger report, July was the largest announced layoffs in its history. A whopping 200% increase on a y-o-y basis. The non-durable manufacturing was down for the first time since 1993. These products are things like personal products, sundries, and food. Perhaps this is a harbinger of increased downside risk to employment and consumption numbers going forward. If companies stayed true to what they claimed that they are seeing the bottoming of the cycle and anticipating a turnaround in 2002, we would not be witnessing such large amount of job cuts.

The latest consumer credit for June was a decline of $1.6 billion, the first drop since November 1997. The Bloomberg survey was for a positive $7.8 billion vs. $6.9 billion for the month of May.

The annual revision of data from the Department of Commerce will perhaps explain why on one hand we have a manufacturing recession, while consumption is still holding up. Profit margins peaked in 1997, and have been dropping since. Money that once flowed into profits went to the American workers, in the form of higher wages. Corporate America has taken up the extra costs while the economy slows. Further job cuts can reduce these costs.

Let's get technical, for the S&P's Consumer Goods Composite Index, the 50-day moving average has broken through the 200-day line in late July.

Waiting for the other shoe to drop? So far, the property prices in both coasts are holding up, though transaction volume have been coming off as of late. If we see a price downturn, then consumption will be further curtailed.

The short-term uncertainty in the equity market might have edged higher, now. However, we believe that accumulation over the next few months for the long-term could turn out to be sagacious.

US Technology

Cautious on technology stocks. On a week-on-week basis, the NASDAQ Composite Index closed 5.3% lower at 1956. Investors have been hungry for news (both company specific as well as economic data related) throughout the week and were left direction-less with scant updates to help in their investment decisions for the near-term.

We believe investors are in a dilemma at the current time. Company specific news have so far been mixed, with Oracle Corp (ORCL US, $15.16, CSFB rating: Strong Buy, CSPB MG V Buy Recommendation List) warning that its August-1Q02 sales will likely fall below pervious estimates due to continued corporate IT spending restraints. Meanwhile, if we were to take the NASDAQ Composite Index as a proxy to represent the overall technology segment, then we potentially have limited downside risk at 1756 (-10%) and 1620 (-17%). This then further implies that an 'easy money' scenario for investors will be low probability outcome. Bullish technology investors will not be able to look forward to a strong rebound in stock prices because technology companies continue to experience sluggish demand (primarily from spending constraints). Bearish traders will have to be more selective in their short trades and be more diligent in protecting their downside profits as fragile sentiment could result in a nasty short squeeze if investors turn positive ahead of the Fed's meeting next week. As a result, we have a bull and bear stand-off, with neither one making any serious attempt to breakout from the near-term deadlock.

Neutral on Cisco Systems (CSCO US $18.33, CSFB rating: Buy). CSCO reported mixed July 4Q01 results with EPS of $0.02 a share, meeting analysts' expectations, while revenues of $4.3 billion declined 25% from

$5.7 billion a year ago. Nevertheless, revenues in the US grew 13% sequentially (and increased 6% on a geographical revenue breakdown basis) due to a relatively stronger demand environment in the US. Other positives that emerged during the period includes the company generating $1.7 billion in operating cash flow and reduced DSOs (day-sales-outstanding) to a record low of 31 days. Although CSCO's results came in line with expectations, investors were disappointed with the company's lack of guidance for the periods ahead. Though near-term visibility has improved, CSCO's management remained cautious about the global economy and the lengthy sales cycle within the telecommunications service provider segment. We are neutral on the company. Given the uncertainties ahead, we believe CSCO stock is not cheap (6.0x price-to-sales and 4.9x price-to-book) and as a result, would not recommend to 'rush' into the stock. With demand visibility still limited and IT spending restrictive in the short-term (1-3 months), we recommend investors maintain a cautious approach to accumulating the issue. For technology-focused investors looking to buy, we recommend to accumulate the stock on further price weakness at $16.00. For those who bought CSCO at much higher purchasing prices, we recommend to Hold and wait for price to weaken towards $16.00 before considering to accumulate more for a 2H02 investment performance.


Europe

How bad can it become? The European stock market lost an average 4.5% for the week with Telecom and Technology shares losing more than 10% on the back of continued weak earnings and a sector downgrade by Credit Suisse First Boston. Further, the market was not able to absorb a placement of 44million shares of Deutsche Telekom. Deutsche Telekom lost almost 20% for the week. The sale was followed by a rumour (source BNP) that 400million shares of Vodafone were about to be placed. Vodafone lost 12% during the last five trading sessions, to a level which we recommend to accumulate the stock for long-term price appreciation. Media stocks and Chemicals were also beaten down, the chemicals on the back of a drug withdrawal together with soft earnings from Bayer.

While the Bank of England (BoE) cut rates two weeks ago, the European Central Bank (ECB) was again seen on the sideline. However, this might change at ECB's next meeting. ECB signalled that growth might be less than expected and inflationary pressure have started to ease. This would leave room to cut rates and help to reduce lending rates in order do stimulate growth. The EURO rallied since this announcement and is currently just shy of the 90 cents level.

The coming week will be determined by core inflation data, consumer sentiments and the ECB rate decision on Aug 14. More than 350 companies are due to report their figures, including Allianz AG, Dresdner Bank, Henkel, UBS (all on 14 Aug); Clariant, Roche Holdings (Aug 15), ABN Amro, Novartis (Aug 16).

Semiconductor industry - Infineon (IFX GY, E24.40) lost almost 15% after CSFB's downgrade. Infineon was the hardest hit as investors sold down the stock on the back of concerns highlighted in the report. However, we believe that the report did not reveal a lot of big news. The market knew most of the facts in the report and other brokerage houses became more positive on this sector lately. Investors used the report as a reason to take profits from recent gains. We continue to believe that semi-conductor stocks are likely to rally in 2002 given its leverage to IT spending. However, we reiterate that these stocks should be bought only through multiple entry strategy due to the high volatility. Other stocks on the recommendation list with semiconductor exposure are Philips (PHIA NA, E29.32, -10.17%) and ST Microelectronic (STM FP, E35.39, -6.22%).

Nokia (NOK1V FH, E20.75, -17.5%) experienced profit taking in the later part of the week after reaching almost E25. Nokia's profit taking set in as one of its customers announced lower spending in IT and general CAPEX. The announcement of another possible bad loan also concerned investors which believed the 25-level was not sustainable. On Friday, Goldman Sachs downgraded hardware stocks including telecom equipment makers such as Nokia. Nokia at current levels appears to offer value for a share price appreciation in late 2002. Ericsson (LMEB SS, SEK 51.5, -5.05%) held up well on the back of some contract announcements.

We continue to recommend a balanced portfolio in Europe with diversification in all major sectors, including some cyclicals (Lafarge / Syngenta / Pechiney / Total Fina), Consumers (Henkel, Carrefour) and Pharmaceuticals (GlaxoSmithKline, Roche).