Stocks to buy in the US in the anticipated correction

US Stocks

We shall see whether the past 3-½ month rise in share prices is justified given the outlook for profits. The recommendation is to look for values after any significant corrections and accumulate stocks with proven track records and franchise that offer an investment return of 10% or better in the next 12 months.

The stocks on our watch list are:

Disney (DIS $21.87) - with mounting debt and plummeting cash flow, management is increasingly under pressure to turn the company's fortune around, if they cannot deliver, it will not be a surprise that Disney will be a takeover target. Using normalized earnings of $0.82, the P/E of Disney is around 26x at current price, and P/B is less than 2x. Therefore, we would suggest accumulating the stock between $18 to $20.

Exxon Mobil (XOM $38.50) - the current EV/EBITDA is 8x, its return on capital continues to be over 2x the weighted average cost of capital. Historically, oil prices have been in the range of $18 to $22, and current oil price is at $20. The levels considered to accumulate the stock are at or below $36.

Dupont (DD $43.02) - after a disastrous venture into genetically modified food, the company is refocusing on its core competency of polymer chemistry, which brought us nylon, Lycra, Teflon, & Kevlar, with a new focus on bio-based materials. The company is putting effort to combine traditional chemistry with biology to create new bio-based materials. That is combining basic chemical processing capability and fundamental engineering skills together with genetics to create new technology platforms. See a good buying opportunity in the $36 to $38 range.

JP Morgan Chase (JPM $38.34) - price will be plagued by the failure of Argentina and Enron in the short term. CSFB expects JPM's risk related to Argentina is now in the range of $1billion-$1.5billion, and $2.6billion in Enron. The total is less than 0.5% of its total asset. JPM will recognize $455 million losses in the 4Q, when it reports on Jan-16-02. Current expectations are low, and is a recovery play once the capital markets and economy pick up. Buying range $32 to $35.


US Technology


Last week's trading activities were largely dominated by news in the semiconductor industry. While the news were fundamentally positive, semiconductor stocks sold-off as investors locked-in short-term capital gains. On a week-on-week basis, the Philadelphia Semiconductor Index fell 3.5% to 568.89 on profit-taking from the previous week's strong 9.4% up-move. We believe the memory segment within the semiconductor industry is still in a consolidation phase, with demand and supply issues showing signs of stabilising. Encouraging developments within the industry include a potential agreement between Micron Technologies (MU US, $35.13, CSFB rating: Hold) and Hynix Semiconductor (0066 KS, Won3,165, CSFB rating: Hold) that is viewed as positive as the global supply of memory chips will be further streamlined and controlled by a few major producers (thus avoiding excess supply). Also, with the unexpected up-tick in demand for memory chips, investors have begun to focus on Samsung Electronics (0593 KS, Won306,000, CSFB rating, Strong Buy) to see if the company will be successful in increasing contract prices again. Conclusion: Turning slightly positive on the sector.

Our stance towards the technology sector remains unchanged. We are still cautious. The next two weeks earnings season will provide some indications on which business is recovering and which requires more patience. In the actual environment we prefer to be invested in software stocks. This segment should see a quicker recovery than the capital intensive hardware area. New applications and broad pipelines in several software companies will be drivers for nice performances ahead. Updates are expected to come out with the quarter results.

All in all, we are not totally pessimistic as it might appear at the first glance. While current valuations are comparable to those in March 2000 (with an average of 20x earnings for the NASDAQ Composite), we believe that the worst is over for technology stocks and expect a cyclical recovery in the 2nd half of the year.


Europe


In our outlook for 2002 we stressed that the scope for valuation was limited as the rally in Q4 already anticipated a great deal of an eventual economic recovery. The plain vanilla of earnings as a driver for equity markets will have to do more in 2002 if the 10% - 15% gains we projected were to be realised. However, the encouraging news to highlight is that there are a few flickers of light on this front already.
Earnings forecasts for European markets fell far less in December than in any month since March 2001. Additionally, the number of downgrades relative to upgrades declined in December on November. However, this breadth indicator for the market as a whole still shows a negative picture with downgrades outnumbering upgrades by a ratio of almost two for one. It is the trend rather than the pure figure that makes us assume that we have reached the trough and things are turning to the better. Our assumption is supported by the recent turn in lead indicators such as the NAPM, IFO and INSEE surveys, which typically correlate well with EPS revisions.

Mining and paper continue to be among the best-placed industries from an earnings revisions perspective. Both sectors feature among the fop five in terms numbers of upgrades. These two sectors have managed to start to raise profitability before the economic recovery is underway. This bodes well for forecast trends when the recovery becomes more visible. The stocks on our recommendation list that represent these industries are Pechiney (PEC FP; EUR 60.20) and Stora Enso (STERV FH; EUR 14.90).

The biggest surprise is that all new economy groups, with the exception of media, appear now in the top half of the 37-member breadth table. In the IT hardware sector December upgrades even outstripped downgrades for the first time since November 2000. This is pretty impressive in our view as for the market as a whole downgrades outnumber upgrades by a ratio of almost two for one (see above). The IT hardware stocks on our recommendation list are Nokia (NOK1V FH; EUR 26.60), STMicroelectronics (STM FP; EUR 37.33), Infineon (IFX GY; EUR 25.60), ASM Lithography (ASML NA; EUR 23.38).

Usinor (USI FP; EUR 14.77) announced plans for a 8-10% price increase for remaining orders in the first quarter and considers raising prices further in the second quarter on the back of higher demand. Additionally, the company confirmed that the merger between Usinor, Aceralia and Arbed should be completed by the end of February. The new company, called Arcelor, will be the world's biggest steelmaker. Even if further price increases might not be imminent we believe that the high level of cost savings out of this merger provides further valuation upside for Usinor. The stock remains one of our preferred cyclicals for the time being. Usinor gained 1.55% for the week.

Telecom Equipment stocks suffered from a sector downgrade to underweight by a prominent broker on the back of concerns regarding demand from Telecom services companies. The number of global handset sales was reduced to 410 million, which is below the consensus of 440- 450 million and capex for infrastructure was reduced to minus 5% in 2002. Our more positive assessment is based on a strong launch of GPRS and a high number of new models that might trigger a strong replacement market. Nokia (NOK1V FH; EUR 26.60) remains our top-pick in the sector. The stock trades close to the lower level of our EUR 25-30 trading range. We recommend using the current weakness as a buying opportunity. Nokia lost 9.46% for the week

Siemens (SIE GY; EUR 76) announced the sale of 40 million shares in Infineon (IFX GY; EUR 25.60) and Infineon itself launched a convertible bond worth EUR 1bln. Infineon immediately denied concerns that the bond issue was related to a worsening trend in the company's cash position. We are encouraged by the underlying earnings trend of this industry (see above) and continue to overweight semiconductor stocks despite high volatility in the months ahead. We consider the current weakness in Infineon as an attractive buying opportunity for clients with a higher risk appetite. Siemens and Infineon closed the week 2.25% and 4.58% lower.

Samsung announced an increase of 30% in DRAM chip prices. This is the third increase since early December. Additionally TSMC announced the sixth consecutive rise in month-on-month sales. This bodes well for Philips (PHIA NA; EUR 33.99), which holds a significant stake in TSMC and ASML (ASML NA; EUR 23.38), which is the main producer of TSMC's machines. There are reports that TSMC is working on full capacity in some of its production lines. We are confident that this will sooner or later trigger orders for new machines. However, traders might use the strong gains over the past two weeks to take some profits ahead of Thursday's earnings report. ASML gained 10.18% for the week.

Vodafone (VOD LN; GBP 1.6750) declined after disappointing subscriber figures of Verizon Wireless in the USA. The decline in subscriber growth in the USA is not really a surprise in the light of the economic weakness. 20% of Vodafone's assets are tied up in an US asset that it does not control. This is a point for concern especially in times like this. However, we believe these issues are US specific and should not have a significant impact on the other 80% outside the USA. Investors should focus on the structural improvements in Europe and Japan. In Europe we see that Vodafone's profitability is improving and there is a good chance that the ARPU (Average Return Per User) will increase in 2H02. We remain positive on Vodafone and reiterate our buy recommendation for investors with a time horizon of 12 months. Technically the stock should hold at around GBP 1.60. Vodafone closed the week 9.09% lower.

Roche (ROG VX; CHF 114.25) came under pressure ahead of a jury verdict on a long-running license agreement dispute with Igen. Igen was seeking compensation of USD 710 million in damages and billions in punitive damages. The jury finally awarded USD 505.4 million to Igen. Roche already announced that they would appeal the decision. Once again the strong support of CHF 108 held and we remain confident that the current level offers an attractive opportunity for a sound restructuring story in the pharmaceutical industry. Roche closed the week almost unchanged.


Mutual Funds


In previous editions of the weekly we tried to evaluate if 2001 will enter the statistics as a growth or a value year. A comparison of the S&P 500/Barra Value Index with the S&P 500/Barra Growth Index shows that 2001 was a value year. However the outperformance of the S&P 500/Barra Value Index was only a slight one: the S&P 500/Barra Value Index returned -11.71% whereas the S&P 500/Barra Growth Index closed the year down -12.73%.

The interesting part to note is that there were as many 'growth' months as there were 'value' months which supports the results of our study ('Is there a choice between value and growth investment styles', 28.11.01) that investors should stay equally balanced between the two styles at all times. As economic indicators fail to clearly predict a 'value' or 'growth' year and frequent switching between stocks/funds of both styles increase investor's risk to miss out on the performance from both styles, we recommend to equally balance the portfolios also with respect to style.

On a global basis, we recommend investors to consider ACM Global Growth Trends as well as ACM Bernstein Global Value. Both funds outperformed their benchmark in 2001. The ACM Global Growth Trends closed the year down 14.44% whereas the MSCI World Index was down 16.50% and the Russell 1000 Growth Index down 16.23% resulting in an outperformance of 200 bps for the year. The ACM Bernstein Value closed 2001 down 4.8% resulting in an outperformance of 1170bps compared to the MSCI World Index and an outperformance of 281bps compared to the Russell 1000 Value Index.


Both funds have each an exposure of around 40 - 60% to the US; the rest is invested in Europe and Japan. The biggest sector weights of the ACM Global Growth Trends are Healthcare (20%), Finance (19%), Communications & Technology (14%) and Consumer Services (8%) whereas ACM Bernstein Global Value is currently exposed to Banks (17%), Oil & Gas (11%) and Insurance (7%). With a minimal overlap (in average only 6%), a combination of these two styles offers a great way for investors to diversify.