ECB expected to cut rates by 25bp

US Stocks

Cisco's Chief Executive John Chambers said that the first few weeks of this quarter (1Q) are meeting Cisco's forecast (0% to -5%) and are beginning to see signs that business is stabilizing. This is certainly comforting news because two weeks ago when CSCO announced its 4Q results, the CEO said that long-term visibility was still challenging, but remained cautiously optimistic that a bottom maybe achieved within the next one to two quarters in the US. This is the same person who said CSCO would grow 30% to 50% in the next 5 to 10 years. Not to mention two months ago, John Chambers said that it was the worst time to go ahead with any sort of restructuring.

Mr. Chambers sure does remind us of a brilliant fund manager whose investment acumen cannot go wrong during the bull market.

Last checked, CSCO was selling at over 52x EV/EBITDA. As for the announced reorganization, CSCO is a company well known for its financial engineering. Be it growth in earnings through the purchase of other companies with stocks, off balance sheet vendor financing (last estimated figure to be closer to US$1 billion), the use of pro forma earnings, and cash flow from stock options being exercised. We doubt that this practice would change anytime soon. Until CSCO comes up with a credible plan to improve its organic growth, we will remain skeptics.

The government has appointed a judge to read and decide a remedy on the Microsoft case. A breakup is still possible, but chances are low at this stage of development. In order to avoid a trail on the bundling issue, an out-of-court settlement is likely. Microsoft has shipped its newest operating system on last Friday, but wide availability of XP is not expected until October 15, 2001. The XP is not involved in the original lawsuit, but the principle of co-mingling the O.S. with other functionality from Microsoft is. Depending on how MSFT is willing to open its architecture and compatibility with third party software, an injunction ordered by the Justice Department will certainly hurt sentiment. Even if no injunction is being ordered, the acceptance of XP in its present format, and that of the Xbox will put MSFT to a severe test. Despite the 5% movement on last Friday, we stick to our view that MSFT is a buy around the $55 to $57 levels.


Europe

Despite German GDP coming to a standstill in Q2 the German business confidence index for July improved for the first time since reaching its all-time high in May 2000. The euro's resilience and ongoing evidence that inflation pressure in Europe is easing offers now more room for the ECB to lower interest rates to help the European economy. The fact that the ECB has lowered interest rates only once this year reflects a higher rate reduction potential than in the US. This will support European shares going forward despite higher correlation of European equity markets to US interest rates.

The improved interest rate outlook does cause us to turn slightly more positive on European equity markets. However, there is no reason to turn outright bullish as we still see no evidence that earnings show any bottoming signs and the issues of inventory overhang and lack of demand in the manufacturing industry remain unsolved. Hence, we do not believe in a strong and sustainable rally until there is more clarification about the 3Q01 earnings. Even though markets do widely anticipate weak results we expect the months of September and October to be volatile again. As seen in Q1 and Q2, the last month of the quarter could again deliver some profit warnings while October has traditionally been a weak month for equities. We believe that these could be the buying opportunities that we have been waiting for. We expect September and October to mark the trough in this bear market and hence we would use weakness to increase the European equities exposure.

The outlook for more rate cuts to come in Europe (consensus expects 75bp until the end of the year) benefits Europe vs. USA. Relative valuation is more in favour of European equities exhibiting both a lower P/E and bond yield to go alongside it. The steepening of the yield curve in Europe favours two sectors in our view, the cyclicals and the financials.

We have been in favour of cyclicals since the beginning of the year and despite outperforming the market there was no significant absolute performance. Since the beginning of the year US cyclicals have outperformed defensives while in Europe the opposite has happened. We expect this gap to close with a more pro-cyclical stance of the ECB. Our preferred cyclicals remain Lafarge (LG FP; EUR 102.90, Pechiney (PEC FP; EUR 56.10) and Syngenta (SYNN VX; CHF 85.35).

Among the financials we prefer to remain on the safer side with insurance companies. Our preferred stocks are ING (INGA NA; EUR 36.51) and Allianz (ALV GY; EUR 317.22). However, should economic growth improve we would start to look at banking stocks, such as Deutsche Bank (DBK GY; EUR 78.70).

ING (INGA NA; EUR 36.51) reported good 1H01 earnings with a 16% increase in net operational profit to EUR 2.403 or EUR 1.24 per share. On the back of the latest US acquisitions net operating profit from insurance operations rose 28.4% to EUR 1.463 while banking operations were much more subdued an grew only by 0.9%. The insurance unit generated a return on equity (ROE) of 20% while the banking unit grew by 16%. We expect the benefits of the integration of the US acquisitions (ReliaStar and Aetna) as well as the cost cutting measures to deliver further improvement in profitability. We believe that the targeted 17% EPS growth for 2001 should be achievable through to 2003. The mix of insurance and banking operations has proven to be a reliable mix in difficult times. ING's valuation based on our price target of EUR 45 (upside 23.25%) remains conservative. ING is our top-pick among financials. BUY.

Zurich Fin. Serv. (ZURN VX; CHF 531) suffered from a rumour that the Swiss insurance company was about to report a USD 1bln loss in its venture capital portfolio. The stock declined 10% on Thursday and recovered the loss the following day. The management categorically denied the rumours and said that alternative investments accounted for only 3% of total investments, of which venture capital investment reflected only a very small portion. Given Zurich's track record these rumours must be taken seriously. However, the company confirmed only a month ago that they were on track to achieve the USD 1.8 - 2bln normalised earnings target this year. We consider Zurich's stock price reaction as overdone but believe that the stock will remain volatile until earnings are released on September 5. HOLD.

TotalFina (FP FP; EUR 164) reported a 6% increase in 1H01 sales. Upstream (exploration and production) activities rose 25% while downstream (refining and marketing) operations grew by less than a percent. In the second quarter revenues grew by 7.5%. TotalFina remains our top-pick among oil stocks. The company will report 1H01 earnings on September 5, 2001. BUY.

Agenda for the week:

Deutsche Tel. August 28, 2001 2Q01 final earn.
Credit Suisse August 29, 2001 2Q01 earnings
ECB August 30, 2001 Interest rates
Syngenta August 30, 2001 2Q01 earnings
Carrefour August 30, 2001 2Q01 earnings
Ahold August 30, 2001 2Q01 earnings
Munich Re August 30, 2001 2Q01 earnings