Not time for bottom fishing yet

US Stocks

When the financial markets are hit by exogenous event like the attack on the World Trade Center, it makes guess work of what the markets will do next to impossible, because psychology more than fundamental takes over. The CBOE volatility index (a measure of expected market swings based on options on the S&P100 Index) was at its highest since October 1998, when investors feared Russia's debt default and the collapse of LTCM would cause a global recession.

Certainly there are values out there, especially when the Discount Cash Flow or Dividend Discount model is being used. Due to the low discount factors (interest rates); the stock valuation may be distorted, particularly in the absence of growth. Furthermore, dividend pay out can be cut or eliminated altogether.

The stock markets are too volatile, and situation too fluid to recommend any serious purchase right now. There will be no quick resolution to the fight against global terrorism; US response is expected to be hard and swift, but this couldl lead to heightened threats within the US. This uncertainty will put pressure on the financial markets. With the waning of consumer confidence and accelerated layoff, perhaps the property price will be the next to go as the balance sheets of the US consumers are highly geared. In times like these, liquidity is preferred to equity investments.

By punting in such an environment, investors might create more risks for themselves. Therefore, we advise to hold until we assess the pending US military move and response to it. After the dust has settled, investors will refocus on the economy and earnings and they might be disappointed.

It is not the time for bottom fishing (yet), rather it is time for due diligence. If there are opportunities out there,we will keep you posted.

The attached table shows the Altman's Z-score and its global ranking as a reference on wireless and long-distance operators for clients who either hold the stocks and /or bonds.

A score above 3 indicates bankruptcy is unlikely, and below 1.8 is possible. The ranking of 4 means the company is in the top 4% and 95 means it is in the bottom 5%. Some of the indicated net dividend yields looked quite attractive as highlighted in blue. We will follow through on these and advise suitable stocks for adding to your portfolio when we think that the price is right. Right now, it is not yet the case.


US Technology

Negative on technology stocks. On a week-on-week basis, the NASDAQ Composite Index plunged 16% to 1423. Looking ahead into the week, we believe investor sentiment will continue to be weak and the index could potentially revisit the 1998 low of 1357. We believe it is still not the time to buy technology stocks.

With the magnitude and duration of the US retaliatory efforts still not known publicly at the present time, investors have become lost with wild speculations as to the subsequent economic impact in the US. Over the week, analyst have reflected their concerns with the current compounded earnings uncertainty (growth expectations were already clouded before the attack) by downgrading (yet again) estimates for technology issues and have further cautioned that the current 3Q01 technology companies' financial performances will be extremely challenging. In terms of technology spending ahead, CSFB believes the renewed economic uncertainty will lead to a pause whereby IT and capital spending plans will potentially be frozen through the remainder of the year.

Downgrading view on the software sector to Negative in the short-term. Along with CSFB, we believe the "exogenous shock to an already weak investment climate combined with a sudden rethinking of priorities" will have the potential to further "push-out" the software segment's earnings recovery scenario (as customers reprioritise from cost savings initiatives to security implementations and disaster recovery).

As such, we believe the Business Software Applications segment will hurt the most during this period (3 to 6 months) as sales slow even more than before. We do not recommend investors to buy into the segment at the current time, nor even to look to average down on cost price for current holdings. For investors who own stocks in this segment, we recommend to HOLD in the short-term, especially given the rapid price decline over the week.

CSFB recently lowered earnings estimates for the following Business Software Applications stocks:

Actuate Corp (ACTU, $4.02, CSFB rating: Buy)
Ariba Inc (ARBA, $2.04, CSFB rating: Hold)
Commerceone (CMRC, $2.33, CSFB rating: Hold)
Documentum (DCTM, $8.19, CSFB rating: Buy)
E.Piphany Inc (EPNY, $4.52, CSFB rating: Hold)
i2 Technologies (ITWO, $4.22, CSFB rating: Hold)
Peregrine Syst (PRGN, $14.26, CSFB rating: Buy)
Retek Inc (RETK, $14.16, CSFB rating: Buy)
Siebel Systems (SEBL, $13.33, CSFB rating: Buy)
Vignette Corp (VIGN, $3.71, CSFB rating: Hold)

Cautious on Palm Inc (PALM US $1.77 CSFB rating: HOLD). PALM, a maker of handheld computing devices, reported Aug-1Q02 losses of $32.4 million. Quarterly sales grew 29.6% sequentially but declined 47% year-on-year to $214 million. The company is facing difficulties in striving for profitability. Demand for PALM's electronic organisers has declined due to the economic slump and has led the company to slash prices in order to clear out excess inventory. The weakness in the current economic condition has also played a huge part in the company's delay in launching its new wireless product (postponed to 2001).

Given (1) the weak macroeconomic environment in the US, (2) the tragic events of September 11, and (3) the aggressive pricing actions by other handheld providers, PALM lowered its outlook for the November quarter. Revenue estimates for 2Q02 are expected to remain unchanged at Aug-1Q01's level of $214 million. Given a gloomy picture for its business conditions and outlook (including high inventory levels), we believe the company needs to review strategies to lower its cost structure to help compensate for the expected lower revenue ahead. We recommend investors not to buy PALM at the current time.


Europe

Capitulation is the catchword these days. If we look at the markets' behaviour over the last few days we can indeed confirm that all the ingredients of a big, final washout are clearly visible. In the period of June-August the daily volume of the Euro STOXX 50 was between 300-400 million shares traded. Since early September this has increased to 500-800 million and found its climax last Friday with 1.20bln shares traded. The heavy volumes were accompanied by high volatility with major indices falling up to 8% intra-day before recovering parts of the lost ground. Option expiry and margin calls have definitely added spice to the growing fears of private and institutional investors alike. Do markets make the same mistakes as in early 2000 again, though the other way round this time? Have valuations and monetary policy become useless as euphoria and greed are replaced by panic and fear? While it is fair to assume that economic and corporate growth will suffer in the months ahead, worst-case scenarios show that equity markets are currently traded below fair value.

With recession looming in the US interest rates will go significantly lower until the end of the year. Expansive central banks and fiscal stimulus (in the USA) do increase the likelihood of a V-shape recovery some time next year. We strongly believe that valuations continue to matter and hence see an increased chance that markets are now overshooting on the downside. As the 'E' for earnings remains at risk in the short-term we expect markets to remain volatile in the weeks ahead. However, long-term investors should not join the overall resignation but use these opportunities to build up positions in quality stocks.

The telecom sector was the best performing industry last week, gaining 6.25% for the week. Telecom stocks managed to recover well after the initial sell-off right after the terrorist attacks. We think that the recent recovery reflects more than just the fact that the telephone compensates for cancelled travel plans. There is some fundamental recovery in sight among some of the European telecom stocks. Especially among the cellulars we see an improving trend of ARPU (Average Return Per User) and margins while the share overhang and debt situation remain a drag on the market (especially among the incumbents).

Investors should focus on balance sheet strength, strong management and global presence. We advise to be extremely selective. Our top-pick remains Vodafone (VOD LN; GBP 1.4150). At current levels we see only limited downside risk in the stock.

We added Sodexho Alliance (SW FP; EUR 43) to our recommendation list. Sodexho Alliance is one of the world's largest food services company providing catering services for hospitals (incl. special nutrition), schools and prisons as well as services such as staffing, building and ground maintenance, laundry installations etc. The company has a history of strong free cash flow generation. We believe that the foodservice sector is unusual in the sense that it offers defensive qualities and yet still offers reasonable prospects for growth.

The growth is likely to be driven by an increase in global foodservice (3-5% p.a. to 2005); an increase in the proportion outsourced (5-6% p.a.) and increased market share of the major players (6-9% total organic growth). We believe that the catering sector is relatively robust within the economic cycle.

Especially the healthcare and education segments (47% of sales) appear to be the least affected through an economic downturn, whereas the Business & Industry segment (49% of sales) is more sensitive to economic growth, which reflects the risk to the stock in the current environment. Sodexho generates 48% of sales in Northern America (of which 2/3 are generated in healthcare & education where growth rates are in excess of 10% p.a.).

Serono (SEO VX; CHF 1195), the Swiss pharmaceutical company was also added to our recommendation list. Serono is a leader in the treatment of infertility, multiple sclerosis and growth hormone deficits and belongs to the fastest growing pharmaceutical companies. Its multiple sclerosis drug Rebif is currently filed for approval with FDA. Test results have shown superior results to Avonex, the drug of market leader Biogen.

We have deleted Zurich Fin. Serv. (ZURN VX; CHF 258) from our recommendation list. Several insurance companies had to increase their estimates for US liabilities between 50%-100% last week. ZFS has disappointed in all possible respects over the last six months. Our incentive to hold on to the stock has always been the fact that the stock is cheap. We stick to this statement but we wonder why the stock has lost almost 50% in the last ten weeks. There is more than the US incidents to blame, such as weak management and the lack of strategy and transparency in earnings guidance.

Additionally, with the current drop in the share prices of insurance stocks the announced IPO of the Re-insurance business becomes increasingly unlikely. Today, ZFS finally announced the sale of Scudder to Deutsche Bank for USD 2.5bln. This is good news and might help the stock to gain some of the lost ground. However, ZFS needs to prove that it can deliver. With investors' confidence deeply disturbed we expect this to take a long time.

We have downgraded Pechiney (PEC FP; EUR 37.87) to 'hold' as we had to suspend our preference for cyclicals. Pechiney might be negatively affected in the short term on the back of uncertain economic growth and cancelled orders for new airplanes. We continue to like Pechiney's fundamentals but see short-term risks for the stock to increase.