Growing confidence over global economic recovery

The first quarter was not a very exciting quarter for investors in European equities. However, the most positive conclusion about the last three months was the growing conviction in the market place that equities have reached a bottom and are now in the stage of establishing a floor with a slightly positive bias. Supported by encouraging economic date over the past few weeks investors are prepared to bet on a recovery on the global economy. This is reflected by the strong performance of cyclical stocks, which are often of medium size. They caused the broad Euro STOXX 600 to post the first quarterly gain in two years. Looking at sector performances though, investors were confronted with a fairly divided market. While cyclicals such as auto (12.97%), industrial goods (10.24%), chemicals (9.98%) and basic resources (5.62%) did well telecoms (-9.99%) and pharmaceuticals (-10.09%) had a difficult time.

Our decision to overweight Europe at the end of last year was correct. The broad based Euro STOXX600, which gained 1.64%, outperformed the S&P500 by 1.70%. Our recommendation list generated a return of 2.19% in the same period. The list outperformed strongly in the first half of the quarter but our rather cautious approach was penalised in the second half as our overweight stance in pharmaceuticals resulted in a negative contribution. At this point in time we do not change this allocation until we get further evidence about the strength of a recovery in earnings. We believe that the 1Q02 reports that are due over the next four weeks will give some evidence about the visibility the companies currently have. Apart from that the last week has shown an interesting shift of money flow into sectors that have underperformed over the past five weeks financed by profit taking in sectors such as auto and basic resources. We expect markets to show more volatility in the weeks ahead as the 1Q02 reports will deliver various surprises.

CSFB published their 2Q02 equity strategy for Europe. The strategist team remains overweight equities but to a lesser degree than in 1Q02. The strategy focuses on three related themes: the need to move beyond the initial inventory-driven recovery theme; a prospective peak in the yield curve; and the risk of a little bit more inflation. CSFB is cutting mining and basic industries to neutral, and general retailing to underweight. They are raising transport and media to overweight, and food retailing and utilities to neutral. The strategists remain overweight in what they call long-duration growth sectors such as life and general insurance, pharmaceuticals and telecoms. Technology remains underweight but with a positive view on software stocks (where our pick remains SAP).

The strategy makes an important point on the early cyclicals that we have made in our weekly of March 18, 2002. These stocks have performed well relative to the market and investors that are overweight in mining and basic resources stocks should consider taking some profits here. We remain sceptical about the upside potential of the telecom sector. Given the high debt levels higher interest rates should have an adverse impact on the P&L of these companies. However, after the recent declines in some of these stocks a technical recovery might be on the cards but investors need to be aware of the risks that are involved in such a strategy.

Apart from other factors European markets were boosted by another positive IFO German business confidence index. The IFO index rose sharply in March to 91.80 from 88.50 in February. The business expectations index also showed a sharp gain and now stands at 106.30 compared with 101 in February. Business conditions disappointed, being only up slightly at 76.90 from 76.80. However historically expectations have led improvements in conditions as well. The sharp gains in the IFO index over the past couple of months confirm that the German economy has made a turnaround and suggests that the economic recovery could be stronger than expected.

We deleted Lafarge (LG FP; EUR 102.40) and TotalFinaElf (FP FP; EUR 177) from our recommendation list.
Lafarge's 2001 earnings were somewhat disappointing, as the beneficial impact of the Blue Circle acquisition did not really come trough. Since our recommendation Lafarge has performed very well on a relative basis. We are concerned that the stock might serve as a source of funds once the market shifts to later stage cyclicals such as cyclical services stocks or media.

The oil price hike on the back of the tensions in the Middle East over the past few weeks was the main driver behind TotalFina's sound performance this year. From a fundamental point of view we believe that oil prices have run up too far and offer downside risk from current levels. Additionally, the valuation gap to the super majors has closed after the strong performance of the stock.

We expect the earnings dynamics of these stocks to stall in the months ahead. Hence, we see only limited upside in the stock from current levels. This is not enough to warrant a buy rating.

Stora Enso (STERV FH; EUR 14.50) suffered from the sale of 23 million shares, which reflect a value of EUR 325.50 million by the Finnish government. After the recent dividend payout and profit taking the stock has reached an attractive level for new investments. We reiterate our buy rating with a price target of EUR 17. The stock lost 2% for the week.

Semiconductor chips had a good week after Infineon (IFX GY; EUR 25.98) confirmed talks about co-operation with Taiwanese chip maker Nanya. Additionally, TSMC announced an increase in semiconductor equipment spending by 50%, which benefited ASML (ASML NA; EUR 28.90). Infineon gained 3.55% and ASML added 7.24% for the week.