Stay out of tech issues, allow falling prices to stabilise and consolidate first

US Stocks

Key components of the NAPM (manufacturing) rose above the 50% threshold, namely-

-production
-new orders
-exports

This has helped the NAPM to register a better than expected 47.9% reading. Nonetheless, price paid was down on its 7th consecutive month. So, production is showing signs of recovery, but the lack of pricing power would not improve profitability.

The index for non-manufacturing business activity fell by 5.5% to a record low. This means that the service sector -which is the bulk of the US economy- has begun to weaken while the manufacturing sector may be poised for a recovery after a year long slide. The labor department reports point to a leveling of job cuts, but weakness in hiring still persists.

The service sector employs about 85% of Americans and accounts for something like 60% of GDP. Consumer spending has been keeping the economy afloat through a sharp decline in manufacturing activity.
If the sector is expected to or becomes unhinged, consumers might, either out of fear or necessity reduce spending. The industries reported decline in business activities last month were:

-communication
-real estate
-wholesale trade
-agriculture
-construction

Only insurance, entertainment, and public administration registered growth.

The retail sales figures coming out this Friday (September-14-01) should give us a better picture.

As for the earnings outlook, where we have visibility, we see weakness. And where we do not have visibility, we anticipate weakness. But at the very least, earnings should start to look better on a y-o-y basis in the 1Q of 2002, since many sectors faced sharp earnings deterioration a year earlier. New accounting rules that no longer require companies to write off, or amortize goodwill and certain other intangible assets would also help profits next year.

US Technology

Cautious on technology stocks. On a week-on-week (WoW) basis, the NASDAQ Composite Index fell a further 6.5% to close the week at 1687.

If we assume the current technology BEAR was born on the weekly close of 7-Apr-00, then the matured BULL has fought with the infant BEAR for a total of 21 weeks (1-Sep-00), with the BEAR emerging as the stronger winner. Since then (8-Sep-00), the BEAR has ruled technology issues with a hungry vengeance, capitalising on the post Y2K spending bust and the subsequent lock-down in technology spendings, to devour technology equity investment portfolios and leaving a red performance trail that is almost 16 months long!

Looking back, and assuming the birth of the technology BULL was on the close of 16-Oct-98 (1620), then the NASDAQ BULL ran for 77 weeks up until 31-Mar-00. However, while the prevailing technology BEAR has also been hunting for 75 weeks already, there are no encouraging fundamental signs to indicate that the mayhem will stop for technology equity-long only investors for the short-term. While no one knows with certainty if the BEAR will finally exhaust from its hunting expedition, we look forward to 1620 as a potentially firm support level to help repel further BEAR sentiment attacks (potential consolidation zone between 1620 and 1480). As such, we again advise investors to stay out of technology issues for the week ahead so as to allow falling prices to stabilise and consolidate.

Neutral to Hewlett Packard (HWP US $18.08 CSFB rating: HOLD) and Compaq (CPQ US $10.59 CSFB rating: HOLD). After a dismal week of continued losses, nervous investors sold off HWP (-22% WoW) and CPQ (-14% WoW) in a 'dumping' fashion after the two PC companies announced their mutual engagement into a single entity. HWP plans to acquire CPQ worth $25 billion in a stock swap. This move will bring HWP annual revenues of $87 billion, enabling the company to save cost by eliminating at least 15,000 full time positions as a result of the merger.

The immediate risk seen to this move is HWP's inexperience with large mergers, which will cost the company an 'arm and leg' for the merger to work successfully. As a combined firm, we expect HWP and CPQ to encounter difficulties in figuring which solutions are best in handling thousands of product offerings, managing an enlarged customer base, and integrating their different management styles. Meanwhile, the anticipated post-merger confusion and the subsequent restructuring process could potentially help Dell Computer (DELL US, $21.55), Sun Microsystems (SUNW US CSFB rating: Buy) and IBM (IBM US CSFB rating: HOLD) capture market share and boost higher revenues in the short-term. We are cautious with the HWP-CPQ merger due to (1) concerns that acquisitions in the PC business rarely work smoothly, (2) lack of a concrete revenue growth strategy to tackle the present industry wide demand weakness, and (3) regulatory approval risk.

Remain Underweight on PC and PC-related issues. We have been cautious on the PC and PC-related segment since the beginning of the year. Looking ahead into the remaining weeks of 2001, we remain underweight PC manufacturers as we believe the sub-sector will continue to under-perform due the sustained weakness in end-user demand. We recommend new investors to avoid the sub-sector.

Europe

Investors will recall the past week as the week when cautious optimism of corporate earnings recovery in early 2002 faded. Despite a positive start to the new week on the back of a good NAPM report optimism quickly changed into panic as Ericsson and Alcatel published a very cautious outlook, German factory orders declined and US unemployment rates jumped much more than expected. Fears that consumers in the US would throw in the towel and thus postpone any recovery of the US and global economy took hold. Despite the sharp declines in recent weeks we do not see a reason to punt into the market now. Investors' sentiment is still not negative enough. We also expect the pre-announcement season to start earlier this quarter, as Ericsson and Alcatel have proven.

Ericsson's (ERICB SS; SEK 40.1) said that it only sees 0%-5% growth in the network industry for 2002. This is a big disappointment since the market expected some recovery at least in the 2H of 2002. Ericsson's statement is of crucial importance. It means most likely that Ericsson will post its first annual loss in more than four decades this year. It also implies that Ericsson will not meet its long-term goals of operating profit at 10% of sales and revenue growth of 20% before 2004! Despite confirmations that more drastic steps will be taken if required we believe that the recovery for Ericsson will take a very long time (i.e. years!).

With yesterday's announcements the pressure on the management is mounting further. We strongly believe that Ericsson's products and network market share are of outstanding quality. However, at this point in time there is no compelling reason to own the stock. Holders of Ericsson shares should hold on to it only if they are prepared to share the long way of recovery with the company. We prefer Nokia (NOK1V FH; EUR 14.35) and recommend using the current weakness to switch Ericsson into Nokia as growth prospects for the latter are better once the market turns around.

Lafarge (LG FP; EUR 98.85) reported a net profit of EUR 242 million or EUR 1.97 per share, which was well above the consensus of EUR 211. However, on an operative level the figures were slightly disappointing with a decline of 14.2%. This reflects the difficult environment in the first half. The higher than expected net figure resulted from lower financial charges, taxes and goodwill amortisation. We believe that the past does not matter that much for Lafarge since the acquisition of Blue Circle accounted only for a few days of 1H01. We are looking forward and expect the integration of Blue Circle and the improving macro environment to have a positive impact on Lafarge's 2H01. Lafarge generates about 25% of revenues in the US, of which a high portion are related to relatively stable infrastructure projects. We reiterate our Buy recommendation at current levels.

Zurich Fin. Serv. (ZURN VX; CHF 425) reported earnings that were in line with expectations. Normalized net income (which smoothes out the effects of realized capital gains) fell 16% to USD 922 million. The company said that it is on track to meet its target of net income of USD 1.8bln - 2bln. Zurich will spin off its reinsurance business in Q4 and float at least 70%. The company said that the US listing would be delayed due to pending asset disposals. Unfortunately, the company made no announcement of a Scudder sale but confirmed that a decision was close to being reached. Losses from Private Equity investments were below USD 50 million. This comes as a relief after rumours that Zurich would report a loss of one billion.

Despite the mildly positive news the stock continued its sell-off on the back of selling pressure from US investors. We argued several times that Zurich's low stock price is a matter of lack of confidence in management rather than bad operative results. Despite the low level of the stock we do not feel comfortable with the company and put our hold rating on review.

TotalFina (FP FP; EUR 160.10) reported good 2Q01 results. Net profit grew by 22% to EUR. 2.13bln, which was ahead of expectations. Operating profit was in line with expectations. Downstream activities generated good results while upstream was solid and chemicals weak. TotalFina expects the rest of the year to remain difficult given the uncertainty about the USD.

The company reiterated its goal of increasing oil production by 6% annually until 2005. This is significantly above the production targets of TotalFina's major competitors such as Royal Dutch (5%) and ExxonMobil (3%). If TotalFina is able to achieve this aggressive production growth target it will be the strongest growing oil company. This confirms our view that the approx. 10% valuation discount of TotalFina against its peers is not justified. We reiterate our Buy recommendation with a price target of EUR 185.