A setback on a disappointing guidance out of Taiwan

The company managed to increase its EPS from $0.50 a year earlier. Net premiums written increased 34%, with the strongest growth coming from the U.S. commercial lines business (+43%). The margin was better than expected in all lines of business, except personal lines. However, that line of business produced a combined ratio below 100%, reversing a trend of seven consecutive quarters of underwriting losses. We believe for the near-term, stock price would remain under pressure due to concerns related to companies with complicated accounting and financing structure. We think AIG is a wealthy company, nevertheless these concerns in these times of worry may make stock price more volatile than in the past. Unclear succession plan of AIG's CEO should also weigh on stock price. On May 1st, the company announced the formation of the Office of the Chairman, which consists of seven most senior executives.

In addition the company named Martin Sullivan and Edmund Tse as co-chief operating officers. This plan is supposed to put several people into consideration, but it did not clarify the situation. AIG repurchased approximately 8 million shares ($530 million) in the first half of 2002. Two weeks ago the company's board authorised to repurchase another 10 million shares. We believe current price level should be attractive for long-term investors able to hold through the near-term market volatility.

Citigroup Inc. (C, $30.74, CSFB recommendation: Strong buy) and JP Morgan Chase & Co (JPM, $22.25, CSFB recommendation: Buy) are investigated by the SEC, seeking proof that the companies helped Enron Corp. in hiding debt. We believe there could be more negative news articles that could emerge in the coming days. C and JPM testimony included many more internal e-mails and transcripts of tape-recorded phone conversations between executives of the banks, Enron, and Arthur Andersen than have thus far been highlighted in the press. We believe banks' role will continue to be scrutinised by the Senate, the SEC and the press. Stock prices should remain under pressure over the near-term. Furthermore the companies could face lawsuits from Enron's shareholders, bondholders and pension funds.

Nevertheless we think companies' finance are sound and we reiterate our hold recommendation. For a long-term investment we prefer to buy Citigroup Inc. on weakness than JP Morgan Chase, although both companies' fundamentals are good. We think that Citigroup Inc. should recover quickly than JP Morgan due to a well-diversified business.



US TECH Equities

On a week-on-week basis, the NASDAQ Composite Index lost 4.32% to 1262.12.

Last week the earnings report of the Taiwan Semiconductor Manufacturing Company, TSMC (TSM US: $8.85; CSFB: Buy), have reminded us to remain cautious with our expectations of a recovery in the tech sector. Despite seeing some positive indicators and forward guidance, we have to keep in mind, how a technology cycle works. So considering the cyclical patterns, some key information from companies that are the earliest to see a cycle pick up, semiconductor capital equipment and manufacturers, are sometimes much more valuable than indications from late cycle sectors, like hardware.

Nevertheless, we have positive data points, which make us somehow confident, that the technology sector is slowly, but steadily getting better. The semiconductor book-to-bill ratio has been constantly rising over the past ten months and been above par since March, indicating an expansion. However, despite being at a strong 1.28 for June, the increase in the book-to-bill ratio has slowed down. It could possibly be, that we see some weakness there in Q3, and TSMC with its guidance and its cut in capital spending, due to weakening orders have given some evidence of that. But TSMC's guidance contradicts the guidance of other chip makers and contract manufacturers, which expect some modest growth for the second half of the year.

So how to proceed for picking stocks in the current market, in order to be well positioned for a return to growth? Because of the mechanism and characteristics of the technology cycles, it is imminent to know, how they work, and who is going to be the first to move. Just looking at the price/earnings ratio may be misleading. We have to see who is going to profit at which stage of the cycle, in order to anticipate this. Saying that, we will see certain stocks appearing expensive on a P/E basis, but outperforming the technology sector, because the price increase is supported by fundamental reasons. If the perspective of improving earnings is not given, there is no reason for an expansion of the P/E multiples in a particular stock. But if we get the hard evidence, that a company sees its end demand improving, we will certainly see a P/E expansion in the company stock.

We expect the semiconductor-related companies to be the first to see the cyclical recovery. This includes the capital equipment maker, chip designers and also the contract manufacturers. Followed by the software sector and later the hardware sector, including server and storage and communication equipment.

On Tuesday we will see semiconductor capital equipment maker KLA-Tecor (KLAC US: $37.29; CSFB: Hold) reporting its earnings, and we are very interested, what the company's guidance will be for the second half of the year. The company is expected to post a $0.2 EPS, according to IBES average estimates.


Europe Equities


• Intraday losses of 6.50% on Wednesday caused the Euro STOXX50 to fall to its lowest level since November 1997. Thursday's technical rally limited the carnage to a weekly loss of 5.88%.


• Even tough a technical rally might be in the cards we do not believe that we have seen the bottom yet. Short-term oriented investors need to be aware of the risks involved in such a strategy.


• Despite the cautious macro-picture investors who want to position themselves for the long run find value emerging in selective sectors such as oil, pharma, selected cyclicals and financials although risks remain high in the latter.


The fact that international equity markets could not follow through on Wednesday's impressive intraday recovery does not support the view that equities have seen the bottom. As Wall Street dictates the pace we do not believe that financial markets have sustainable upside potential over the next few weeks. Investors need to bear in mind that August 14, 2002, the day by which US CEOs and CFOs will have to swear that their books are clean, remains a crucial day for international equity markets and hence high volatility is guaranteed. Already now, there are 2.2 companies downgrading earnings for each one upgrading them. With CFOs becoming more conservative in their guidance we feel supported in our view that equity markets might look more attractively valued now but they are not necessarily cheap at this point in time. The valuation case would become even more severe if we were to see a short-term technical rebound.

While the US problems must not necessarily apply for European equities (and we still think rightly so) we do not see any compelling reason for Europe to de-link from the US fundamentals on a broader picture. However, as corporate governance is less of an issue we believe that some value is emerging in some sectors. In the case of the pharmaceuticals and the oil stocks we expect the potential of earnings disappointments to be rather low, which is why we consider the current levels attractive for investors who are not too concerned about the current volatility.

Despite a 2.56% weekly loss European pharmaceutical enjoyed some positive newsflow. Market concerns over a weak first half for Novartis (NOVN VX; CHF 58.15) failed to materialise with the group reporting EPS up 5% to CHF 1.51 (consensus CHF 1.46). Subsequent approvals for Zelnorm in the US and Zometa in Europe helped the stock to close the week almost 16% higher. Following Bristol-Myers Squibb's report of weaker-than-expected Plavix sales, largely owing to continued de-stocking, Sanofi-Synthelabo (SAN FP; EUR 54.25) reported similarly soft Plavix sales in the first half, although US prescription demand remains strong at 36%, and market sales are up 56% year-to-date. Importantly, management maintained the full-year outlook for net income growth of at least 25%. Based on these forecasts the stock trades at a P/E 02E and 03E ratio of 22.7x and 18.9x, which reflects a P/E-to-growth ratio of well below 1.

The European oil stocks have fallen significantly of late despite holding up a strong performance versus the market for much of the last 6 months. A recent driver of the poor performance has been the ejection of Royal Dutch from the S&P 500 index. This has driven down both Royal Dutch and Shell. We believe the other European integrateds including TotalFinaElf (FP FP; EUR 134.50) and ENI (ENI IM; EUR 13.97) have been sold down on the back of this news to release funds for purchase of RD/Shell shares at reduced prices. From a fundamental point of view we like ENI and TotalFinaElf. We believe that a dividend yield of 3.25% for TotalFinaElf and 5.35% for ENI (which has also a share buy-back program running) offers a strong downside protection for these two shares. There remains limited risk of earnings downgrades in the sector. According to CSFB's valuation method the European oil sector is about 25% cheap, which implies that current stock prices discount long-term oil prices well below USD 17/bl (current price is USD 26).

We will also add Nestle (NESN VX; CHF 316) to our recommendation list. At the current P/E03E level of 15.2x Nestle appears cheap to us compared with its peers, such as Danone (17.6x) and Kraft (15.6x). While we remain cautious on the food sector due to the strong relative performance over the past two years we believe that Nestle's recent sharp drop has been overdone. In the absence of any convincing sign that the bear market is over the food sector is expected to be viewed as a safe haven.

Stora Enso (STERV FH; EUR 10.75) reported 2Q02 results that fell short of our expectations due to unexpectedly poor volumes and higher costs than expected. The long-awaited demand recovery appears to have been delayed. However, with a strong balance sheet and strong cash flow Stora Enso can afford to wait for the recovery. The company's commitment to supply discipline confirms our view of a structural change in the way the paper industry operates with long-term positive implications for over-the-cycle returns. At current price levels we believe that Stora Enso has priced a lot of potential disappointments. The stock is traded at a P/E03E level of 7.4x and offers a dividend yield of 4.15%. Stora Enso is well known for its reliable dividend policy.

Pechiney (PEC FP; EUR 38) reported earnings from operation of EUR 137 million (consensus 115 million) and confirmed that it is on track to achieve the target of EUR 450 million in savings from restructuring until end of 2004. However, the company said that it would only be able to reach its earlier guidance of a profit from operations similar to last year if the price of aluminium was at a level of USD1450/t (currently USD 1310) and the Euro exchange rate at 0.90, a scenario that looks challenging at this point in time. Despite the recent losses in the stock we retain our buy rating on the back of its attractive valuation (P/E 03E; 8.40x) but suspect that the stock might be underperforming until we receive evidence of an economic recovery.