Volatile markets

Apart from the FOMC meeting the release of business confidence indices in France (INSE) and Germany (IFO) will be the market's key focus for the week. We expect the FED to leave interest rates unchanged.


US Markets


Last Friday we recommended Electronic Data Systems Corp. (EDS, $17.79, CSFB recommendation: Outperform) for a trading idea after the company announced its third quarter profit will be a fifth of what it had forecasted. This sharp reduction is due to lower spending on computer service, and contracts from corporations. We believe corporate IT spending would continue to be weak as long as companies' earnings stay weak. Nevertheless, the 52% price decline is over-done. Trading buy

With these volatile markets, we believe gold mining stocks could offer an alternative to investment portfolios due to its negative correlation to the major stock indices. Gold mining companies continue to reduce their hedge books, in expectation of higher gold prices. We like Placer Dome Inc. (PDG, $10.45, CSFB recommendation: Not covered) - Buy. Valuation is attractive, and stock has a beta (vs. the S&P 500) below 1 (0.02), and a negative (-0.513) five-year correlation. Placer Dome's balance sheet is relatively safe, with a debt/equity ratio of 56.07% and a debt to assets of 29.42%. Like the sector, the company reduced its gold hedge book over the past weeks, which lifts off some costs related to the hedging and gives a bigger leverage to the gold price. PDG announced an extension of its take-over offer to shareholders of AurionGold to October 2nd. So far, the company reached 42.5% of AurionGold (source Merrill Lynch). Though the company is facing unrest at its Papua New Guinea Porgera gold mine, we believe once the current vandalism is under control, earnings would recover. The company cut Porgera's production forecast by 120,000 ounces to 560,000. Finally, company's copper production currently runs on low margins, due to historically low copper prices. An improvement in copper prices or reduction in production costs would be an added bonus.

Citigroup Inc. (C, $26.83, CSFB recommendation: Outperform) stock price is under pressure due to concerns on its profit forecast. Analysts are lowering their earnings forecast for 2002 and 2003 and we believe this downgrade is not over. Citigroup's earnings would be hit by a weaker-than-expected Global Corporate and Investment Bank (GCIB) business. Nevertheless, we wish to reiterate that Citigroup's finances remain sound and the company would remain profitable due to a well-diversified business. The company has more than $1 trillion in total assets, and management has demonstrated that they can deliver 16% p.a. growth in the past 5 years. Nevertheless, our hold recommendation still stands due to the unsettling market condition.

General Dynamics Corp. (GD, $83.02, CSFB recommendation: Neutral), which announced two weeks ago the addition of three new aircraft to its business jet line, expects profits will be upheld by its new Gulfstream business jet and strong military business. With a P/E of 17x, compared with the P/E of the aerospace & defence sector (22x), GD stock price is trading at a 22% discount and current sell-off is overdone. The spectre of war has reinforced our Buy recommendation in spite of concerns related to civil aviation weakness, which could pressure stock price in the short term

Boeing Co. (BA, $36.48, CSFB recommendation: Outperform) avoided a strike from its machinists union, contract with its second largest union, the Society of Professional Engineering Employees in Aerospace (SPEEA), will expire but in December '02. In addition, weak new deliveries for 2002 and 2003 (further airlines bankruptcies, travel impacted by potential war in Iraq,...) continue to hammer the stock. Longer-term we believe Boeing would benefit from strong earnings from its military business. Morgan Stanley estimates sales volume in defence sector would rise from 40% in 2000 to more than 55% in 2004. Finally, for investors anxious about Boeing's exposure to United Airlines Inc. (UAL, $2.49, CSFB recommendation: Underperform), SASI does not think a likely bankruptcy of UAL would affect Boeing due to a well-diversified business base, especially in the defence sector. We agree that this bankruptcy would not affect BA's finances. But if UAL goes bankrupt, stock price could react negatively, although it is well expected by the market. Hold.

European Equities


Profit and revenue warnings on both sides of the Atlantic as well as gloomy economic data caused European markets to reach 5-year lows. In its fourth weekly decline the Euro STOXX50 declined 8.80%.

EDS' profit warning and Alcatel's revenue warning gave further evidence how dire the situation in the technology industry is. With little hope of improvement in sight technology stocks fell 11.34% for the week.

The razor-thin victory of the old German government does not make further reforms easier.

Apart from the FOMC meeting the release of business confidence indices in France (INSE) and Germany (IFO) will be the market's key focus for the week. We expect the FED to leave interest rates unchanged.

After a nasty and tough election campaign the existing coalition of social democrats and Greens under Chancellor Schroeder has emerged as the winner in a race that was too close to call until late in the night. However, there will be little time to party since the election campaign has once again made the public aware of the most pressing problems of a weak economy, an unemployment rate that has risen in 19 out of the last 20 months and stretched foreign relations after Chancellor Schroeder's decision to talk tough on the US plans to deal with Iraq. Especially the latter might have shifted the pendulum in favour of Mr. Schroeder but the razor-thin lead of the new government will not make things any easier in the months and years ahead. The short-term diversion on international politics cannot hide the fact that Germany's economy is weak and needs urgent and radical reforms to find back on the path of growth.
With Germany accounting for about one third of the pan-European GDP it is obvious that the result of these elections is more than just an internal affair. The expected decline in this week's German (IFO; estimate 88) and French (INSE; 95) business confidence indices will reflect the impact of higher oil prices, tumbling stock markets and rising concerns about the implications of a possible war in the Middle East.

With these problems in mind it is possible to explain why European stock markets (STOXX600; -32.29%) have broadly underperformed the US markets (S&P 500; -26.36%) despite an up-to-date absence of accounting and fraud cases. With our forecast of European markets breaking the July 24, 2002 lows confirmed the technical situation of the European market has also deteriorated. With all these issues in mind it is hard to see a reason to turn more positive on European equity markets even though the sharp losses might tempt investors to adopt a bottom-fishing strategy. Despite the possibility of a technical rebound (especially if this week's economic data are not as bad as expected) we would caution investors about the high risks involved in such an approach. We stick to our defensive stance and recommend selling stocks that have lost their competitive advantage.

Nestle (NESN VX; CHF 321) was the bright exception in last week's gloom, closing the week 1.60% higher. Hershey Trust, the potential seller of a majority stake in Hershey Foods, announced that plans to sell the company were dropped and all offers rejected. With concerns regarding earnings dilution out of the way Nestle will be able to focus on its fundamentals, which continue to look attractive. Nestle is traded at a discount to the food sector despite industry leadership. We continue to recommend buying the stock between CHF 310-320.

JCDecaux (DEC FP; EUR 11.57) reported a 5% increase in net income to EUR 11.5 million or EUR 0.05 per diluted share. This was right in line with CSFB's forecasts for profits after goodwill. The outdoor advertising and billboard business achieved EBITDA growth of 3.4% and 38% respectively, while the transport advertising business (mainly airports) reached about break-even. JCDecaux expects 2H02 sales to be little changed from the first half. We continue to like JCDecaux due to its very unique business model. However, despite the fact that the company is performing better than the industry it is obvious that earnings growth can only be achieved if the advertising industry starts seeing a pick-up in economic growth. In that sense JCDecaux remains a cyclical company with attractive fundamentals that is traded below its long-term potential, in our view.

Zurich Fin. Services (ZURN VX; CHF 124.25) announced the conditions of the right issue that was announced two weeks ago. The company plans to issue two new shares for three old ones at a price of about CHF 65. This ratio came as a surprise as the market widely expected a one-to-one issue at a more discounted price. However, the stock price was negatively affected by the strong decline in insurance stocks (-13.80% for the week) on the back of Aegon (AGN NA; EUR 10.50) placing EUR 350 million shares into the market and Swiss Life (RAN VX; CHF 129.75) announcing its first loss ever.

The OPEC decided to leave oil production quotas unchanged. Our view on the sector is that especially with current market conditions and the risk of military action in Iraq ahead the sector is defensive. But there are risks that aggressive production targets will be missed. Another reason for concern is the fact that costs are rising and underlying returns falling. For the time being we expect the oil sector to be a relative outperformer. However, if sentiment for the market changes (although no signs visible at this point in time) we would expect this sector to underperform. Our preferred stocks remain TotalFinaElf (FP FP; EUR 130.20) and ENI (ENI IM; EUR 13.957). We see fair value for TotalFinaElf at EUR 160 at for ENI at EUR 16.50, which reflects an upside potential of 23% and 18% respectively.