New legislation and the market risk

US STOCKS

The 'Big W' signed into law legislation granting the government new powers to police the accounting profession and increasing prison terms for rogue executives. The President and Congress once again demonstrated that they could be quite effective when push came to shove, as Americans vote with their pockets. Notwithstanding whether the latest legislation can completely fill the loopholes, nonetheless, it is a start. We have no illusion that President Bush will try to lead the reform, but rather taking a more passive role.

What's new:


• The accounting oversight board under the SEC will set standards for accountants and review their audits


• It will cover oversea firms performing work for US corporations


• Prohibits accounting firm from providing 9 types of consulting services to audit clients (they may seek a waiver)


• Firms that seek non-audit services needs approval from independent directors on the company's board


• Securities fraud will be made a crime that carries a maximum of 25 years in prison


• Increases penalties


• Chief executives will have to vouch for their companies' financial statements and may be subject to jail terms and fines if they knowingly deceive in disclosures


• Company has to notify SEC within 1 day on information that has an impact on their financial statements


• The SEC will set rules on what information is covered


• Makes easier for investors to recover losses in case of securities fraud


• SEC has to draft rules with regards to conflict of interest for stock analyst who research companies that also are investment-banking clients of their firms


• Bars retaliation against researchers who issue 'sell' recommendations on clients' stocks

CEOs will have to sign the affidavits when their companies file their next financial statement or report a significant event after August 14, 2002. Corporations will have to wait until spring for their next audited annual reports to straighten out their books. Therefore the risk of further accounting surprises will be with us for a while. Meanwhile, the under-funded pensions will be a drain on earnings.

Given the current market risk, the risk and reward is definitely not favourable though there are values in the market.

JP Morgan Chase & Co. (JPM, $23.85, CSFB recommendation: Buy): At the time of the merger between the old Chase and the old JP Morgan, the company announced its intent to be a top five equity player in three years and a top three player within five years. The management is focusing initially on improving the operating structure and related personnel, which sounds right.

For the long-term growth, JPM's greatest challenge in the equity business could be its ability to create a highly profitable secondary equity business. At the moment, according to Autex/BlockData, the company does not rank in the top 10 in domestic listed/OTC trading market share nor does it appear in the top 10 European Ordinary/ADR market share league tables. For the short-term, although the stock could appear cheap, headline risk remains significant. However, if the company would be able to increase its market share in the secondary equity business, this should offer to JPM sustainable growth. Hold


We are more positive on Citigroup Inc. (C, $30.88, CSFB recommendation: Strong buy) than on JP Morgan Chase $ Co due to stronger fundamentals. Like JPM, headline risk remains high and regulatory/legal issues may not dissipate for several months. C might have to contend with lawsuits from Enron's shareholders, bondholders and pension funds. However it seems that investors have lost sight of C's earnings and capital strength. The company has $95 billion in capital and $4 billion per quarter in earnings. Hold

Countrywide Credit Industries Inc. (CCR, $49.03, CSFB recommendation: N/A) reported 2Q'02 earnings per share of $1.48, beating consensus' expectations ($1.345), and increasing 23% y-o-y. This surprise was due to low interest rates, which helped home sales and mortgage refinancing. The company, the largest independent mortgage lender, should be well positioned for a mortgage-refinancing peak in 2H'02. However we remain cautious on this due to declining consumer confidence and construction spending. On a positive note, the sale of excess servicing demonstrates that a liquid market exists for such sales and the valuation that Countrywide Credit Industries Inc. booked ($320 million) reflects current market condition. Hold.



US TECH STOCKS

On a week-on-week basis, the NASDAQ Composite Index lost 1.11% to 1247.92.

The relative weak economic numbers that came out last week raised concerns about the state of the economy and the near term outlook, which led to a sell off in technology stocks in the second half of the week. The week-on-week performance of the Nasdaq Composite does not reflect the roller coaster ride the index had during the last week, with a peak at 1354.48 points on Tuesday. We have then seen a selling into this rally. People who have been holding on to their technology investments in expectation of a recovery in the second half of the year, might consider selling their positions, as the economical data suggest that the expectations might be to optimistic. We are rising our caution again, as we believe that volatility will remain high without much upside potential, as the selling into strength might continue. We would also keep a low weighting in the sector relative to the market, and stick to quality, good valuations and solid balance sheets.

The risks of a prolongation of the current weakness in IT spending will be more acute for companies burning cash, and especially if they are operating in areas that might not be seeing a slight improvement in demand over the next six to nine months.

On of the most awaited upcoming events this week is the quarter report of Cisco Systems (CSCO: $11.89; CSFB: Buy), due on Tuesday 6, after market closing. The company has been in the news during the last week and rumours that the CEO and CFO might have to quit, after refusing to certify the company's financial statements, in accordance to a new securities rule, will need some explications.

Cisco Systems has been quite active in acquiring smaller competitors in the last couple of years, now rising investors scrutiny about the booking of these acquisitions. Regarding the revenues and earnings, there seems to be more confidence. First Call analyst poll results in an EPS of 12 cents, excluding some expenses, versus 2 cents last year, and an increase in sales by 14% to $4.89 billion. More important will be the company's guidance, or possible changes in guidance, given the latest economic data.


EUROPE


• Hopes of a sustained recovery proved to be premature. The Euro STOXX50 closed the week down 0.40%.


• Weak US GDP and ISM figures confirm our cautious stance. The economic recovery remains weak and hence earnings forecasts are likely to be reduced further for the second half of the year.


• We reduced Allianz to Hold from Buy.

ENI (ENI IM; EUR 15.05) reported a 22% decline in operating profit to EUR 1.88bln, which was in line with consensus. ENI does not publish quarterly net profits. The company expects an average oil price for the second half of the year of USD 25. We do not believe that this is reflected in the current share price. In fact, current share prices among the European leaders reflect an oil price of below USD 20 rather than the proposed USD 25 by ENI and hence we reiterate our positive stance on this sector. ENI confirmed that the dividend of EUR 0.75/share should be maintainable if oil prices remain around current levels. The company said that share buybacks were speeded up in July resulting in 183 million shares or EUR 2.5bln. This leaves another EUR 3.9bln for share buy backs over the next eight months. With a dividend yield of 5% and a share buyback program in place we see little downside risk in the stock. Additionally, the combination of high production growth, cost reduction and a valuation discount of more than 10% to the majors makes ENI an undervalued play among European equities in our view.

Aventis (AVE FP; EUR 65.05) reported an increase in 2Q02 earnings of 30% to EUR 507 million or EUR 0.64 per share and a sales increase of 11%. This was pretty much in line with expectations. The most reassuring message was the confirmation of Aventis' guidance. The management reiterated its forecast for a 25%-30% increase in profits and 11% in sales for the full year. Sales for its core products Allegra (rhinitis), Taxoterre (cancer) and Lovenox (thrombosis) as well as for its most promising new drugs (Ketek & Lantus) were slightly ahead of our forecasts. The management said that there was no update to the stance of the patent dispute on Allegra, which generated an increase in sales of 28% to EUR 565 million. The strong earnings figures show that the company continues to succeed in increasing the quality of its product mix. We reiterate our positive stance on the stock and our medium-term target of EUR 90. We would use any weakness to buy the stock for investors with a multi-year outlook.

Given the troubles in the insurance sector Allianz' (ALV GY; EUR 133.49) profit warning came not as a complete surprise. The company abandoned its 2002 profit forecast of EUR 3bln and said that it will post a 2Q02 loss of EUR 350 million due to write-downs on investments and a bigger than expected loss at its banking unit Dresdner (higher bankruptcies, losses in Latin America), where the integration apparently poses much more problems than initially expected. Allianz announced a massive restructuring programme for its banking unit, which will include separating Dresdner's loans into a new unit to free up risk capital and job cuts of up to 3000. These measures should help to save EUR 2bln next year. Allianz reassured the market that it still has sufficient reserves of more than EUR 10bln on its investments (Deutsche Bank, Munich Re, BASF and E.On). Given the uncertainties in the sector and short-term rating and earnings downgrades we reduced Allianz to 'Hold'. From a long-term point of view we consider the current stock price interesting. However, in the short-term insurance stocks remain a leveraged play on equity markets and hence stocks could fall further over the next few months. Allianz lost 8.57% for the week.

Celanese (CZZ GY; EUR 19.94) posted better than expected 2Q02 earnings. The company published net income of EUR 22 million versus consensus forecasts of a loss of EUR 500.000. Celanese was negatively affected by the weak US dollar but pointed out that successful restructuring measures more than offset this impact. The company saw business improving in the second quarter compared to the first but remained cautious for the rest of the year even though full-year guidance was confirmed. We reiterate our buy rating on the stock but expect a sustainable recovery to be delayed. We believe that the strong management and the highly cyclical business Celanese is in make the stock attractive for investors who believe in an economic recovery led by the USA. Celanese generates more than half of its revenues in the USA. On an EV/EBITDA basis Celanese is trading at a discount of 36% on 2002 estimates and 23% on 2003. On a P/E basis Celanese is traded at a multiple of 16.1x for 2002 and 6.5x for 2003. We believe Celanese's attractive valuation should limit the downside risk from current levels. Celanese gained 12% for the week.

SAP (SAP GY; EUR 71.79) received a contract to develop supply chain software for Ford Motors and Caterpillar. The complete product will be developed and implemented at Ford pilot sites in about three years and is expected to reduce logistics costs and improve the companies' services for spare parts. This is one of SAP's biggest orders in about three years. During the earnings presentation SAP mentioned that contract volumes have declined due to reduced corporate spending. In that sense, this is good news but does not change the fact that companies will refrain from committing additional money to new projects until earnings start picking up