Still cautious on technology stocks, advise against buying for now

US Stocks

The index is calculated as follows:

(advances / declines) / (advance volumes / decline volumes)

A ratio of less than 1 indicate a bullish market, whereas a value over 1 indicates a bearish market.

As of the close of 30 August 01, the figure is 2.28 and 2.23 for the NYSE and NASDAQ respectively. The three-month average for NYSE is 1.24 & 1.45 for the NASDAQ.

The flip side is that the volume of sell orders in declining stocks has been unusually high, which is saying there is intense pessimism among investors and that presages a market bottom. In any case, value stocks with good earnings prospects should lead the recovery.

November crude oil rose to $27.16 in short covering and OPEC will start its production cuts on the first of September. Both Exxon (XOM $40.15) and Burlington Resources (BR $38) look interesting at current levels.

Seems like for every positive data that came out, there is a negative one. Last Friday's July Factory Orders was better than expected, but according to the Manufacturers Alliance survey, 75% of US industries showed a pronounced and deepening decline in business activities during the 2Q, the latest figure is down 20% y-o-y. Consumer spending is still holding up, but the latest delinquency rate on credit cards jumped in July for the 8th straight month to 5.06% from 4.44% a year ago.

Thursday's jobless claims and Friday's unemployment rate hopefully will give us some indications as to whether the consumer will continue to spend. If you still believe in the merit of buy and hold, you might consider accumulating value stocks in the months ahead.

US Technology

Cautious on technology stocks. On a week-on-week basis, the NASDAQ Composite Index continued its decline to end the week 5.8% lower at 1805.

Friday's up-tick move on the NASDAQ does not represent a change in depressive near-term sentiment. We believe the bias is firmly towards the downside, with 1756 (-2.7% away) as being the first Index risk level and 1620 (-10.2% from current levels) as the next potential risk-support point. With investors remaining uncommitted towards technology stock investments, we remain cautious towards technology issues and recommend a Hold strategy in the short-term. The technology Bear market is still firmly in place and presently, there is little positive news to stem a further decline for the week ahead.

Given that we expect technology issues to weaken further, what can we do now (other than wait)?

For investors who own the NASDAQ-100 Index tracking stock (QQQ US, $36.17), we suggest exploring an options strategy to capitalise on the near-term distressed environment. Assuming that price on the QQQs is anticipated to decline further in the near-term towards a potential consolidation zone (between $35.00 and $28.30), we suggest aggressive investors to consider riding the continued near-term downtrend move by investing in one of the following options strategies.

Buying short-dated PUT options.
Bloomberg Code:QQQ US 9/01 P36.00
Maturity: 22 September 2001
Strike Price:$36.00
Last Option Price:$1.30
Shares per Option:100 shares
Premium to pay: $130 ($1.30 x 100)
Breakeven price:$34.70

The Buyer of 1 QQQ PUT option contract, upon payment of the premium ($130.00), acquires the right to sell 100 QQQ shares at $36.00 (with the option expiring on 22 September 2001).

Strategy is to hold the option to maturity or look to close out the long PUT option position by selling back 1 QQQ September 36 PUT options when the option price reaches $3.00 to lock-in a total gain of $1.70 ($3.00-$1.30).

The investor is bearish on the underlying option issue (expect price of QQQ to depreciate).

The investor has the risk of losing $130 per option contract if the underlying stock (QQQ) price is above the strike price on maturity.

The Seller of 1 QQQ PUT option, upon receipt of the premium ($320.00), has the obligation to buy 100 QQQ shares at $36.00 (with the option expiring on 22 December 2001).

Strategy is to hold the option to maturity (22-Dec-01) or look to close out the short PUT option position by buying back 1 QQQ December 36 PUT option when the option price falls to $1.80 to lock-in a total gain of $1.40 ($3.20-$1.80).

The investor is neutral-to-positive on the underlying option issue (expect QQQ to be relatively stable).

The investor faces the risk of being assigned the underlying stock (QQQ) if the underlying stock's price is below the strike price ($36.00) at any time before maturity. In this scenario, the investor faces the risk of having to buy 100 QQQ shares at $36.00 with a potential cash outlay of $3,280 ($32.80 x 100).

Also, the investor has the risk of losing performance on the underlying stock (QQQ) if the underlying stock's price continues to depreciate past the breakeven price ($32.80) on maturity.

Selling long-dated PUT options to sponsor the purchase of near-term PUT options.

The investor is bearish in the near-term but at the same time he has an improved outlook for the end of the year.
Look to close out the long PUT option position by selling back 2 QQQ September 36 PUT options when the option price reaches $3.00 to lock-in a total gain of $3.40 ($3.00-$1.30 x 2).

Look to close out the short PUT option position by buying back 1 QQQ December 36 PUT option when the option price falls to $1.80 to lock-in a total gain of $1.40 ($3.20-$1.80).
The investor has the risk of losing $130 per option contract if the underlying stock (QQQ) price is above the strike price on maturity in September.

The investor faces the risk of being assigned the underlying stock (QQQ) if the underlying stock's price is below the strike price ($36.00) at any time before maturity in December 2001. In this scenario, the investor faces the risk of having to buy 100 QQQ shares at $36.00 with a potential cash outlay of $3,280 ($32.80 x 100).

Europe

Concerns about a delay of a recovery in the US economy and disappointing consumer confidence figures caused August to post the second worst monthly performance for the year. The Euro STOXX 50 Index lost 8.48% and USD 396bn was wiped from the market capitalisation of the 600-member European STOXX Index in August. With this in mind it appears little surprising that technology stocks performed the worst (-19.59%).

However, the more encouraging point is that energy stocks and some of the cyclical sectors such as banks, basic resources and construction managed to gain slightly or lose only little. We believe that earnings forecasts for banks remain too optimistic for the second half of 2001 and hence we remain cautious on this sector.

On the other hand we continue to like energy as well as the basic resources and construction sectors. The fact that these sectors still show positive year-to-date returns (Europe STOXX: -17.27%) should not discourage investors from buying them. With the Euro stabilising at higher levels and inflation pressure easing the ECB should have reasons to lower interest rates more aggressively, which would cause the yield curve to steepen. Coupled with stabilising leading indicators this has been the best time for cyclicals. European cyclicals have underperformed US peers and appear cheap at current levels.

We expect buying opportunities for cyclical stocks in the next two months. Even though 3Q01 earnings reports will disappoint we expect markets to focus on future developments rather than on the past. Our preferred cyclical stocks remain unchanged, Lafarge (LG FP; EUR 99.85), Pechiney (PEC FP; EUR 54.30) and Syngenta (SYNN VX; CHF 87.25). We also consider DaimlerChrysler, BASF and Stora Enso as attractive buying opportunities in further weakness.

Syngenta reported 1H01 earnings at the low end of expectations. Operating performance was disappointing with net income excl. extraordinary items at CHF 400 million versus expectations of CHF 444. The surprising factor came from the cost cutting programme. Syngenta reported savings from cost cutting measures of CHF 70 million in the first half and expects another CHF 80 million in the second half. This is CHF 60 million more than expected. We believe that the cost cutting story and the attractive valuation will support the share price until the US economy picks up. This would strengthen the cyclical element of the stock. BUY

Carrefour (EUR 58.55) posted good net profit but disappointing EBITDA figures due to higher marketing costs and one off charges. 1H01 profits before ex items rose 6% to EUR 320 million. Sales rose 9% with an increase in France and rest of Europe and a decline in the Americas. Most importantly and in line with management forecasts, sales in the second quarter grew at a faster pace than in the first.

Carrefour expects this trend to continue for the rest of the year. The company reiterated its earlier guidance of 15% growth in profit (ex goodwill) and 8% in sales, mainly due to improvements in Europe and Asia. Attributable profits for the first half accounted for only 25% of full-year figures. In order to meet these targets profits would have to grow by 19% in the second half. We believe this is possible as last year's growth rate for this period was at 16.5%. With an EV/EBITDA of 10.5x the stock is valued well below the sector average of 12.6x. BUY

Nokia (NOK1V FH; EUR 17.23) continued its sell-off, further underperforming the sector. Nokia's sharp decline in August (-30%) reflects the increasing scepticism of investors towards the company's guidance. Nokia is expecting 3Q01 EPS to remain flat YoY (EUR 0.14-0.16), sales to grow 5% and operating margins to be in the high teens. In the light of the slow summer months, increasing price pressure and news that the company is behind schedule in the shipment of new GPRS phones, we increasingly believe that these targets are very ambitious. Despite the recent decline we believe that it is too late to sell but also too early to buy the stock. HOLD

Zurich Fin. Services (ZURN VX; CHF 471.50) lost 11% for the week. The market takes a very cautious stance ahead of the earnings release on September 5, 2001. Rumours continue to spread around that the company is about to announce the sale of its fund management company Scudder. We believe that the announcement of an asset sale will be crucial in order to give the market the confidence that the company is really generating cash. However, given the difficult market environment the price for such an asset could cause disappointment. HOLD