We expect European markets to fall below the levels of July 24, 2002

US Markets


• Recommendation update

The Bank of New York Company, Inc. (BK, $32.57, CSFB recommendation: Outperform) is one of the gainer of volatility in the equity and fixed income markets. According to the street, the company should have several potential processing-asset management-related acquisitions in the pipeline, following a recent pattern of healthy acquisition related growth. Stock price may not experience the significant bounce back associated with the more capital markets-driven players, but could nevertheless gain from the company's earnings diversity and stable high growth business model. The company is involved in seven major types of processing businesses including depositary receipts, corporate trust, stock transfer, global custody, securities clearance, securities lending, and unit investment trusts. We stay with our hold recommendation due to current market volatility, but we remain positive in the long term.

Two weeks ago, in the Gabelli Aerospace Supplier conference in New York, the suppliers presented a gloomy outlook for commercial aerospace. Some of them do not expect a recovery until 2004. This would be critical for suppliers without exposure to military related business. While civil aftermarket is expected to be sharply lower for this year, suppliers see some stabilisation in sales, and some signs of a pick-up outside the U.S. The respite comes from the defence sector, where orders from the U.S. military continue to be strong.

Boeing Co. (BA, $35.58, CSFB recommendation: Outperform) narrowly avoided a strike. 62% of machinists rejected the contract from the company and 61% wanted a strike. Nevertheless, under the union's rules, the contract is accepted and the strike is rejected because the limit of 2/3 of the machinists was not reached. This would allow Boeing new job-flexibility rules, which would help the company manage its business in the current weak environment. We believe management would not wait long before cutting jobs due to continuing losses in airlines. We remain cautious for the coming months on the company. High U.S. defence expenses is currently supporting stock price, but it is difficult to say if they would remain as commercial aviation business remains weak. Hold

General Dynamics Corp. (GD, $83.02, CSFB recommendation: Neutral) announced recently the addition of three new aircraft to its business jet line. The new Gulfstream will fill in the gaps between its existing models, and the full line will include seven aircrafts that rage in price from $11.5-44.8 million. It would be able to offer business jets more suitable for its customers. Furthermore, with the new models, the company covers the complete spectrum of business jet market without increasing extremely its costs. The new jets are based on existing Gulfstream models and the company already received a $1.5 billion order for 50 new Gulfstream and an option for 50 more. The company won a $3.17 billion contract from the U.S. Navy to build destroyers. 48% of GD's business is related to the U.S. Army and its allies. In spite of a weak commercial aviation business, we remain positive on the company (target price $100) due to its exposure to military sector.


• The OPEC in the spotlight

On the 19th of September the OPEC will meet in Osaka to decide on their output quotas. So far several members have shown reluctance to increase the output, with the reason that they see the increase more as a result of the tension on Iraq, rather than from the demand side. In fact the inventories are around 5% below the five-year average inventories, which were recorded during a phase of economical growth. Given the weak demand growth trend, risks from the supply side are not imminent, despite the coming winter in the Northern Hemisphere. It will be a balancing act for the OPEC to try to meet the market demand for an increase, while not creating an oversupply, given the market conditions. This meeting is probably one of the most important in the recent years. Under normal market condition it would have been a clear call for an increase in quotas, but the situation is a bit more complex this time. The tensions in Iraq add a political note to the debate. While several members of the OPEC focus on the economical perspectives of the supply, Saudi Arabia in a support for the US would like to increase quotas in order to meet the demand for lower oil prices.

Until the OPEC has made a decision on their quotas, we could see some volatility in these stocks, but fundamentals remain sound. We recommend Schlumberger (SLB, $42.62, CSFB recommendation: Neutral) and Noble Corp (NE, $30.28, CSFB recommendation: Neutral) as Buys.

Lucent (LU, $1.26, CSFB recommendation: Neutral) forecasted its sixth straight quarter sales decline. It would fall as much as 25% from the last quarter's $2.95 billion. Its loss per share before certain expenses will be almost three times as big as analysts forecasted. Beside weak sales, Lucent also faces the default of some of its customers, for which Lucent has been doing vendor financing. The company will trim its business and lay off more staff. With the additional cost cutting, Lucent expects to reach break-even by the end of its fiscal year 2003 on sales of $2.5-3 billion. This sale forecast however implies a solid growth from the current quarter expectations, which is quite optimistic, from Lucent, as a broad consensus forecast does not see a recovery in the optical gear business before the end of 2003. The risk is to the downside and we are cautious on the optical equipment sector, as it remains plagued by over-capacity.



European Equities


• Disappointing economic data and corporate statements drive risk premiums higher and equity markets lower. The Euro STOXX50 declined 3.34%. This marks the third consecutive weekly loss or a 33.5% decline year-to-date.


• Insurance (-9.32%) and technology stocks (-4.03%) are once more affected by negative newsflow. We recommend staying clear off these sectors.

There seems to be no end to the string of negative newsflow. The rhetoric on Iraq is heating up. Additionally, France reduced its 3Q02 GDP guidance, the Michigan consumer confidence index was below expectations and last but not least bellwether companies like Philips, France Telecom and Allianz surprised the market with negative news. In such a doomsday environment it is obvious that investors require a higher risk premium for investments made in equities versus bonds. The current risk premium of about 3% reflects the highest level since 1985. One might assume that this should give markets a certain support. However, with September historically being a weak month and only little hope of improving newsflow in the weeks ahead we expect European markets to fall below the recent lows marked on July 24, 2002. The Euro STOXX50 closed the week only 3.65% shy of this level. A fall below the level of 2438.31 would set a chart-technically negative signal for markets. Such a sell-off could trigger a buying opportunity for trading oriented investors sometime in Q4. For the time being we remain cautious and would not advise to commit new funds.

Philips (PHIA NA; EUR 17.27) hit the market with a major disappointment as it reduced 3Q02 sales guidance for its semiconductor unit. Philips expects sales to fall between 13% and 15% in euro terms compared to the second quarter. This comes after an earlier guidance of a decline between 2% and 5%. The company blames the revision on the stronger euro and a further decline in demand. Philips intends to reduce supply further by shutting down production sites and by introducing additional restructuring measures, which will require an extraordinary charge of EUR 200-225 million in the next six months. Philips expects a slight recovery in Q4 with a sequential increase between 7% and 12%. The wide range of the guidance reflects the lack of visibility in the industry and increases the risk of disappointments. Though trading at the lower end of the valuation range we do not think that the stock is cheap enough to buy.

Some good news came from LVMH (MC FP; EUR 41.78). The company reported a 19% increase in operating profits based on strong performances in champagne and wines, where operating profits increased by 44% over the past six months. Losses in selective retailing were reduced by more than half and LVMH reiterated its plans to break even with DFS by the end of the year. These numbers were slightly ahead of expectations. The company reiterated its earlier guidance of a 'significant rebound' in operating profits for the full year. We believe that the long-term potential of LVMH is not reflected in the current share price. However, with the war on Iraq looming, consumer confidence and consumption could be affected negatively.

Nokia (NOK1V FH; EUR 14.22) surprised the market by lowering its sales guidance for the third quarter from a range of EUR 7.2-7.6bln to EUR 7.1-7.4bln due to increased weakness in the networking sector where sales are expected to fall by approx. 5% compared to last year. Nokia confirmed its EPS guidance of EUR 0.15-0.17 and estimates that the final result will be closer to the upper end of the range. The handphone unit continues to do very well based on a strong demand pick-up from Europe. Despite the launch of a series of new phones the company expects handphone margins to be at 20% or above. We remain concerned about the ongoing strategy of the company to cut sales forecasts. Based on the guidance given for 3Q Nokia would have to post a year-on-year sales increase of more than 25% in Q4 if full-year guidance were to be reached. Despite a series of new models coming up (the first 3G-phone is scheduled to be launched on September 26, 2002) we believe this is way too optimistic and hence expect 4Q02 sales guidance to be cut sometime in November.

Nestle (NESN VX; CHF 316) has been range trading since the bidding process for Hershey Foods has started. A US court has blocked the deal a few days ago on concerns that the sale would cause 'irreparable harm' to the company's home community. The seller of the stake, Hershey Trust, has appealed the ruling and a final decision is still outstanding. According to newspaper reports Nestle plans a joint-bid with Cadbury Schweppes (CBRY LN; GBP 4.6250) in which the latter is thought to commit about GBP 3bln or 46% of the deal. Such a combination is widely seen as the best solution and makes Nestle the frontrunner in the bid. However, as long as the details are not confirmed we expect the stock to remain volatile. We would use a level between CHF 300-310 to buy the stock.

After an almost 50% year-to-date decline in the European insurance sector it appears difficult to come up with further disappointments. Allianz (ALV GY; EUR 100.20) managed to do exactly this when it announced that it had to inject USD 750 million into its US Fireman's Fund Insurance Co. to cover asbestos related risks. This is the third time the company has to increase its provisions for potential asbestos claims. With no trigger for improving equity markets in sight, insurance stocks remain in a vicious circle despite our belief that the current levels reflect attractive long-term valuations.