Cautious on US Tech as expecting some weakness to come (page 1 of 4)

US Stocks
The combination of recession, the war against terrorism, and volatile capital markets created more confusion and uncertainities than before. The market kept swinging between bouts of optimism and pessimism. The rapid military success in Afghanistan was encouraging, but the concerns about new terrorist attacks remained. We are skeptical that a strong rebound in the economy is at hand.

Various indicators are telling us there is plenty of liquidity, and return on cash is low. But both stocks and bonds are not cheap.

The current US slowdown is quite broad- based unlike previous recessions in the mid-1970s and 1980 to 1982, which were caused by higher energy prices that hurt the industrial sector, but help the oil & gas industries. The recession of 1990 to 1991, featured overbuilt real estates and the end of the cold war, which negatively impacted the defense industries.

This recession has spread from the information, computer, & telecommunication to the traditional sectors like autos, steel, textiles, furniture, paper, chemicals, tourism, & transportation industries.

This cycle has been associated with excess supply, and the deflationary effect it brings has been hurting corporate profits. This helps to explain why sharp declines in interest rates failed to stimulate growth. Earnings will take longer than expected to recover, as there is still excess capacity in the manufacturing sector. Currently, the utilization rate is only at 75%, for the technology sector is even lower at 60% with the rate for semiconductor and telecommunication equipment at 58% & 64% respectively.

Furthermore, corporate lay-off has yet to stabilize.

The current US 10-year Treasury bond is yielding at 5.10%, and is considered risk free. And the latest rally from the year lows after the Sep-11 attack has made the stock markets expensive on an earnings yield basis.

Both tech & non-tech stocks have made nice gains form the their lows in anticipation of an economy turnaround that is expected to happen sometime in the 2H of 2002. The combination of liquidity and relative valuation is the main driver for the current rally; not an improvement of the fundamentals. Further gains are possible, but the fact that the rally began from a high valuation will cap the upside, rather than prevent prices from making any gains.

This 1Q will see the reporting season for the 2001 4Q results. We do not expect profits will be what the market had hoped for. Stock selection will be the key.


New US-GAAP for amortizing goodwill

Although US equity analysts are aware of the the new US-GAAP (Generally Accepted Accounting Principles) rules for amortizing goodwill many investors might not be familiar with them. Here is a short summary:

1. Not only US companies are subject to these new rules, also foreign companies reporting according to US-GAAP (like for example ABB or Ciba SC) will have to adapt them.

2.Goodwill is calculated when companies merge or make acquisitions and basically consists of the excess price above the fair market value of net assets acquired under the purchase method of accounting. The goodwill mirrors the premium of all assets which are not in the balance sheet such as: Image, brand names, growth possibilities, market position, patents etc.

3.Under the old US-GAAP rules, this goodwill became amortized in equal installments over a certain period of time. Under the new rules (effective as of 2002) goodwill now remains "frozen" in the balance sheet and its value will be checked and revalued in yearly intervals.