Further downside bias for technology stock prices

US Stocks

In the last 12 months, the DJIA declined by 14.20% and the NASDAQ was down by over 56%. On a relative basis the Dow outperformed the NASDAQ. The main reason for this is that the rotation out of the TMT sectors (Telecommunication, Media, & Technology) continued to benefit the non-tech stocks in the DJIA.

Of the 15 component stocks that outperformed the DJIA, only SBC Communication is in the TMT group. On average, the group has gained 9.7% and outperformed the DJIA index by close to 24%. By default, these stocks were being bought up to quite high valuation. From an earnings perspective, these valuations do not reflect the trending down of profit growth. The stocks in this group are poised for a fall if the economy starts to turn south.

The second group also consists of 15 components stocks that underperformed the Dow. The average loss was over 33% and the group underperformed the index by 19%. The largest loss came from the technology (hardware) and financial sectors. The weakness of the financials are particularly worrying. Perhaps, this is heralding the coming economic slowdown. In terms of earnings, the group did not fare better. The trend is still pointing down, although showing signs of stability. But the group has more negative estimates relative to the first group. If we get a full-fledged recession, these stocks cannot avoid further sell-off pressure, because their earnings estimates have to be revised further down.

If we get a respite from the reopening of the stock markets due to the efforts of the world's central banks, then our clients may consider raising some cash. Perhaps it will be the calm before the storm.

US Technology

Cautious on technology stocks. Last week, we suggested to investors to stay out of technology issues to allow falling prices to stabilise and consolidate first. This week, we reiterate the same recommendation to "HOLD", especially after the tragic events from last week in the US and the subsequent increase in uncertainty (on an IT spending rebound and earnings pick-up). Expectations on technology stock price movements for the week ahead will be biased towards the downside as investors remain concerned about company earnings. Nevertheless, we look forward to the NASDAQ Composite index to potentially consolidate between 1620 and 1480.

Software maker Oracle Corporation (ORCL US $11.46 CSFB rating: Strong Buy) reported Aug 1Q02 earnings of $510.6 millions last week. Sales were flat from last year at $2.54 billion. The company's net income met its lowered expectations, but appears to be continuing to struggle. EPS of $0.09 beat expectations of $0.08 a share. The company is facing the toughest market it has seen in 10 years, which we believe to be an indication for investors to remain cautious in the short-term. To add, ORCL and the rest of the software industry do not see an end to the slump in sight. ORCL's database new licence revenue declined 26% yoy (year-on-year) in the US (total database revenue declined -8% yoy) due to the slow economy and increased competition from Microsoft Corporation (MSFT US $57.58 CSFB rating: Strong Buy) and IBM (IBM US $96.47 CSFB rating: Hold).

The company's application business (new licence revenues) has also shrunk at an alarming rate of -56% sequentially (year-on-year fall of -6%). We believe ORCL's current conditions illustrate how tough the next few months will be for the software sector in general. For investors who own the stock, we recommend to HOLD in the short-term to allow price to settle down first.


Europe

At this point in time it is difficult to quantify the implications of this terrible tragedy for financial markets. There are too many uncertainties, such as consumer sentiment and the sort of political and military responses that could affect markets. As equity markets dislike nothing more than uncertainties, we expect markets to remain volatile in the weeks to come. However, the equity market already had quite a lot of capitulation within it before Tuesday. This might act as a certain support in the weeks ahead and causes us not to sell good quality stocks at current levels.

In fact, history has proven that stock markets tend to overreact to catastrophes and geopolitical shocks. European markets lost 22% within ten weeks after Iraq's invasion of Kuwait and recovered three-quarters of this within the following eight months. Provided the crisis does not escalate we would assume that a great deal of the damage is done. However, the chances of an immediate rebound are very slim, which causes us to remain cautious. Any kind of sustainable recovery will take a long time and investors will have enough time to start buying once the dust has settled.

With US consumer sentiment at risk, it becomes increasingly clear that the global economic recovery is likely postponed by a few quarters. This has implications for our investment strategy. In times as uncertain as now, investors should focus on more defensive sectors, such as pharmaceuticals and selective food and utilities, even though the latter two remain expensive. We particularly like to highlight the pharmaceutical sector. Current valuations of European pharmaceuticals look attractive with implied growth rates about 20% below the 10-year average. We do not believe that a delay of the economic recovery threatens the growth forecasts of this industry.

Consequently we added Aventis (AVE FP; EUR 73.15) to our recommendation list. Aventis has a young and strong product pipeline and is not too much dependant on new products since less than 10% of the next five years growth lies in the pipeline. On an EV/EBITDA basis Aventis is traded at a 30% discount to the global pharma sector. We think this is not justified and recommend buying the stock in the current weakness.

We have been positive on cyclicals since quite some time. With the economic recovery postponed it will take longer for performance to materialise. We continue to like early cyclicals, such as basic materials and construction, as valuations remain attractive but expect them to remain under pressure in the short-term.

Cyclical consumer goods (-23.5%) and insurance (-14.26%) stocks have been the most affected last week. Blue chips stocks, such as Philips (-24.5%), DaimlerChrysler (-23.50%) and ING (-16%) have been seriously affected. Even though all these stocks look attractive we would be patient for now.

The only piece of good news came from Nokia (NOK1V FH EUR 15.74), which closed the week 10% higher. The company confirmed its 3Q guidance on Tuesday only two hours before the tragedy in the USA began. Nokia said that sales would decline by about 5%. This was below earlier guidance. However, Nokia confirmed that 3Q01 margins would be in the mid-teens and earnings would be in the range of EUR 0.14-0.16. The company sees demand for mobile phones in the USA picking up. Fundamentally we remain cautious on the sector given the uncertainties regarding the global consumer sentiment. Traders, however, should make use of the current volatility in the market.

Henkel ( HEN3 GY EUR 67.88) hit our stop-loss level of EUR 68. We deleted the stock from our recommendation list with a loss of 3.5% since our recommendation on January 2, 2001. The stock has held up very well compared to the market. The company announced the long-awaited sale of Cognis, its chemical unit, for EUR 2.6bln. This will allow Henkel to be rated closer in line with its peers, such as Unilever or L'Oreal.