We expect another volatile week ahead and recommend using strength to reduce positions

Based on these assumptions markets are still not cheap. Poor economic data suggest that the ECB will have to lower interest rates before the end of the year or early next year.

United States


• Aerospace and defence sector overview

• A look inside Intel

Citigroup Inc. (C, $30.28, CSFB recommendation: Outperform) stock price continues to be under pressure from negative press. The company has been the subject of a negative news article on almost a daily basis. With probably more negative press to come as potentially more hearings, investigations, and lawsuits regarding alleged wrongdoing at the company's corporate and investment bank, we reiterate our hold recommendation. However we think that investors have over-reacted. We remain positive on Citigroup for the long-term, but expect stock price should remain volatile in the short-term. The company has sound fundamentals and a well-diversified business base. Furthermore, Citigroup should be one of the beneficiaries of an economic recovery.

Commercial aerospace stocks had another bad month in August, brought on by the weakness in the business aircraft market. The US Airways bankruptcy and Boeing's labour crisis put additional downward pressure on companies with significant civil aviation exposure. Meanwhile, defence stocks enjoyed a positive month, continuing their strong performance. Several factors such as the continued focus on the war against terrorism, positive political developments (the upcoming election and Congressional action on the fiscal year 2003 budget), and the continued likelihood that company guidance would still be conservative should act as positive catalysts for the group. However an improving economy could pose some risk to defence stock performance. Defence stock returns have historically had a mild negative correlation with the economic growth. Over the past 20 years, correlation between defence sector and GDP growth is negative (-0.33; source JP Morgan). Furthermore a number of issues could continue to put pressure on commercial aircraft, such as an invasion of Iraq, further terrorist attacks, and more airline bankruptcies.

Boeing Co. (BA, $37.21, CSFB recommendation: Outperform): while there have been some last minute attempts by government mediators to avert a strike by Boeing's machinist union, we think a work stoppage is likely. The company is standing firm on its key issue, which is job security. Job guarantee would constrain the company's ability to be competitive in an environment that would require a smaller labour force due to the cyclical downturn, and loss of market share vs. Airbus. In spite of Boeing's military division, which should provide a cushion, we reiterate our hold recommendation due to a severe downturn in the commercial aviation business and high chance of a strike.

General Dynamics Corp. (GD, $77.00, CSFB recommendation: Neutral) is also facing a weak civil aviation market. Concerns related to a multi-years declining jet market have risen. In the current market condition, we believe GD would not generate significant growth from its private jet unit. Furthermore the company lost several military contracts, which have increased pressure on the stock price. The company should be able to generate growth with its military business (50% in GD's figures in 2001). Among its units, information services, and combat systems should see higher profit. Buy.


Last Thursday Intel (INTC, $16.22, CSFB recommendation: Neutral) reported revised guidance, there was uncertainty in the market related to this revision, it would have resulted in rising volatility for technology stocks. But the outcome was less significant, than it had been anticipated. Intel just cut off $200 million on the top end of its revenue guidance given during the last quarter report. Intel now expects sales to be between $6.3-6.7 billion. Reasons were the weak back to school sales and ongoing slow dynamics in the corporate PC replacement cycle. But the company expects profitability to rise from the second quarter, thanks to a reduction in production costs related to increased outsourcing of manufacturing processes and new technologies in manufacturing. There is some room for improvement in profitability, since Intel currently has operating margins of 9.25%. These low operating margins of course are related to the weak demand and the resulting capacity utilisation. But since Intel did not want to give any indication on the fourth quarter, which would give a hint towards the expectations for the Christmas season, we believe that visibility remains low and that demand for PC's weak. From this point of view, Intel's share price valuation look quite stretched. For example from a price to sales perspective Intel trades at 4.06x (average for the SOX Index is 3.2x, average for the S&P500 Index is 1.92x) with an operating margins of 9.25%. So in terms of profitability, there is some risk to the bottom line and thus Intel share price given the current chip market perspectives is quite expensive, even with the minimal cut in the company's guidance. We do not expect the sector to see a pick up by the end of the year, as even if Christmas sales might be relatively strong, the corporate PC market is very likely to remain weak, given the uncertain economical environment.

So as a conclusion of our view on Intel's guidance and outlook, we would remain neutral on the chip sector, as we believe the current valuations anticipate a return to solid growth for the year 2003. We do not share this optimism, unless we get more data points related to the semiconductor sector, that shows a clear path to recovery.

Europe Equities


• Only a 'last-minute rally' prevented European markets from posting one of the worst weekly performances of the year. The Euro STOXX50 closed the week 3.36% lower.

As media headlines are focused on the weakness of the US macroeconomic data headlines seem to pay little attention to the figures that come out of Europe. While US data seem to paint a mixed picture the situation in Europe appears pretty clear. Key economic data point to extensive weakness, especially in Germany where last week's factory orders and retail sales figures are just another piece in the puzzle that things are about to head for a double dip. With the ECB coming back from their summer holiday this week (September 12) and future growth risks increasing we consider a rate cut increasingly likely. However, this is unlikely to happen before the end of the year despite our assumption that economic data will remain weak for the remainder of the year. The reason for this is that the ECB continue to focus on inflation. Headline inflation is projected to be above 2% until January next year and the ECB will be very wary about lowering rates before it has more convincing evidence that inflation really will be below 2% next year. This outlook is likely to be of little support for equities, in our view.

After a somewhat disappointing earnings report (operating profits and margins below expectations) Sanofi-Synthelabo (SAN FP; EUR 57.95) managed to recover from the early-week losses. Despite comments that sales' growth in the second half of the year would slow down it is worth pointing out that Sanofi-Synthelabo's growth still exceeds the industry be more than 50%. On the back of the recent losses the stock's valuation premium has been halved to about 10% over the past few months. Taking valuation and growth into consideration we believe that Sanofi-Synthelabo looks attractive in the mid-50s. With Plavix being the main uncertainty factor we see the stock trading in a range of EUR 50-70 and hence the current upside is significantly bigger than the risk to the downside.

Arcelor (LOR FP; EUR 11.60) reported its first 2Q results. These figures were clearly ahead of expectations with a net profit of EUR 111 million versus consensus estimates of EUR 38 million. Keeping in mind that the 1H02 was a very difficult quarter in the light of the depressed steel price and the weak global economy we believe that this is an excellent result. The second half should deliver even better results. The steel price has gained about 35% from its lows reached in early 2002, which underlines our investment case of a sequential earnings recovery for Arcelor and the steel sector. With a P/E03E of about 7x Arcelor is traded at a significant discount to its peers. Given its market leadership and the benefit from the restructuring program we see no reason for such a discount to exist and remain positive on the stock. However, the ongoing negative macroeconomic newsflow could put a cap on the stock in the near term. Investors should adopt a 12-18 months investment horizon.


TotalFinaElf (FP FP; EUR 143) reported a decline of 23% YoY in 2Q02 net income before extraordinary items to EUR 1.632bln. These figures were very much in line with expectations. The decline is mainly based on an 8% lower oil price compared to last year and lower refinery margins, which declined 67% on the back of reduced demand due to the global economic weakness. TotalFinaElf confirmed its goal of 10% growth in oil and gas output for this year and reiterated its target for growth of 6% through 2007. With medium-term targets twice that of Exxon and more than the 5.5% of BP TotalFinaElf continues to grow volumes faster than its major competitors. In the short-term TotalFinaElf's share price will depend on external factors (politics and OPEC meeting on September 19). From a valuation point of view we see fair value between EUR 160 and 170.

Roche (ROG VX; CHF 105.25) announced the long-awaited sale of its vitamin unit to Dutch specialty chemical maker DSM for EUR 2.25bln. According to analysts the price is considered to be rather on the lower side. However, more important than the price is the fact that Roche can now focus on its two core businesses, diagnostics and pharma. The company will generate about 90% of its revenues from these two units. With this transaction and the recent acquisition of the majority interest in Chugai the company has made two important steps to become a focused and well-positioned company. Additionally Roche confirmed that it is on track to sell Pegasys this year and to achieve sales growth of 10% next year. We consider this as two reassuring steps that Roche's transformation is solidly on track.

At last, Zurich Financial Services (ZURN VX; CHF 146.50) announced the kind of decisive action investors have been waiting for a long time. ZFS plans to cut 4500 jobs and raise new capital in the range of USD 2-2.5bln. The Swiss insurer posted a 1H02 loss of USD 2.029bln. Apart from the share sale ZFS intends to strengthen its capital base by selling assets worth about USD 1bln in the next 6-9months and reducing its equity exposure to 10%, which should release additional capital of USD 500 million. ZFS plans to concentrate on its core insurance business and will build on its position in its chosen core markets of Northern America, the UK and central Europe in particular Switzerland, Germany, Italy and Spain. In the future ZFS will assess its operating performance relative to its target operating ROE of 12% over the medium term. Management expects that the impact of this program on 2003 profit after tax will be in excess of USD 1bln. The bitter medicine is now prescribed and the fact that there is a plan was taken positively by the market. The ball is now with the management to deliver on this plan, which will be the more challenging part of the story.