After a long period of bad news the newsflow turned slightly more positive

US Markets

Since the last high, on August 22nd, S&P 500 lost more than 14%. Among the index, gold (6.84%), healthcare suppliers (+4.64%), agricultural products (+3.97%), and casinos & gaming (+0.70) were the industry groups with a positive return for the period, while 43 groups with a return lower than the S&P 500 drove the market down. We think a rebound in the near-term is quite possible. Negative sentiment reached a level where we feel a large part of the bad news has already be priced in, and stabilisation on even a single U.S. economic figure could set off a rebound.

However we still believe this in no way signals a bull run, and remain cautious over the medium to long term. Fears of a U.S. economy on the brink of deflation, the risk of war, and concerns over fishy corporate accounting are well and truly alive. Furthermore we believe dividends offered by the companies do not offset the downside risk.

In the case deflation, financials as well as companies with large borrowings like General Electric Co. (GE, $24.47, CSFB recommendation: Neutral) or Ford Motor Co. (F, $9.63, CSFB recommendation: Outperform) should be especially vulnerable. Rather, we would rather recommend investing in companies with low debt levels, low betas, and high dividend yields like The Macerich Co. (MAC, $31.04, CSFB recommendation: Not covered).

If there are indeed beneficiaries from a war with Iraq, defence-related companies like General Dynamics Corp. (GD, $82.19, CSFB recommendation: Neutral) or Northrop Grumman Corp. (NOC, $126.76, CSFB recommendation: Restricted) are well positioned as the need to replenish military stockpiles arise. Oil services companies like Schlumberger Ltd (SLB, $39.82, CSFB recommendation: Neutral) should also incur custom in the form of reconstruction. According to SASI, besides oil service companies, they believe building companies like Caterpillar Inc. (CAT, $37.50, CSFB recommendation: Outperform) or Deere & Co. (DE, $45.01, CSFB recommendation: Outperform) would be also benefit from the rebuilding of Iraq's infrastructure.

On the food and beverage front, Philip Morris (MO US) has taken a drubbing as the company last week announced that they were lowering their profit forecasts to reflect additional promo spending. The second of such hikes this year. The move comes as MO attempts to curb the growth of discount brands and counterfeit products, which have seen a resurgence as the US economy continues to sputter. The price gap continues to increase between MO's premier brands and the deep discount players. We reiterate that MO remains operationally sound unlike its rivals at RJR and believe that the stock will remain relatively resilient over the current squall. We believe that MO will undoubtedly remain weak, but should start to show that it is of good breed as the promo spending starts to bear fruit come the end of 1Q03. That said, we would watch the stock over the next couple of trading sessions to revaluate our position on MO and possibly come up with some option strategies. For investors who already own the stock, we would recommend they sell into strength if the stock does turn around over the week.

Southwest Airlines (LUV US, USD12.73, CSFB recommendation: outperform) has also been going through a rough patch with the stock down 8% on Friday to USD12.73. We would like to reiterate our positive stance on the best performing stock in the US airline industry. Here is also some food for thought: 1) LUV's share price took a pounding on the lead up to Gulf War I, but appreciated 70% through March 1991. We do not believe that the other players are as financially sound as they were back in 1991 to participate in a potential rally, but we believe that if anyone can LUV can. 2) LUV's share price may go down in sympathy with the market, but investor concern will be based principally on international travel whereas LUV operates exclusively within the US. 3) Any concern over a spike in oil prices should be mitigated by the fact that 80% of its fuel needs are hedged at USD22-24 for the September and December quarters. 4) The company is financially the soundest US carrier at present with USD2.1bn in cash and access to a further USD575mn via an unsecured revolving credit facility.

European Equities


• Better than expected German (IFO) and French (INSE) business confidence indices and positive comments from BMW, Peugeot and Serono brightened sentiment for a change.

• From a risk-reward angle we would play a potential technical rally through the pharma sector. We would use the early-week weakness to build up trading positions in Aventis, Sanofi-Synthelabo and Novartis.

The German (IFO) and French business confidence indices acted as a clear relief to the market. The IFO index showed its fourth consecutive monthly decline from 88.8 to 88.2, which was above the 88 consensus. Despite the fact that the outlook for future business fell more than expected and reached an eight month low the market focused on the headline figures of these important leading indicators as well as a lower than expected French unemployment rate of 9% for August. While our outlook for equity markets remains cautious we believe that markets might be due for a technical reaction, which could be quite significant and last for a few weeks. We consider this scenario as a typical rally in a bear market, which we mentioned several times in previous weeklies.

In that respect this week's ISM (formerly NAPM) and US employment report (Friday) could have important implications for equity markets. Despite encouraging signs that a short-term rally could be in the cards we strongly advise investors to consider investments from a risk/reward angle, i.e. the total equity exposure must be kept in mind and valuations of the potential buying candidates must be attractive. From a risk/reward angle we believe that the pharmaceutical sector offers an attractive opportunity. Although European pharmaceuticals are traded at a 40% premium to the US peers we believe that the valuations of selective European companies do not reflect their earnings potential, which is well above average. In that respect Aventis (AVE FP; EUR 55.85) looks particularly interesting.

The company is expected to post 18% earnings growth over the next five years, which is well above the 7%-9% estimate for the industry. Aventis has a strong portfolio of upcoming and outstanding products. We think that Aventis' stock price has been too much penalised for its risk of losing its patent protection on Allegra. Aventis currently trades at a P/E03E ratio of 16x. Given these strong fundamentals we believe that the slight discount to the European sector average of 16.9x is not justified and even less so is the 28% discount on an EV/EBITDA level.

Although more expensive and slightly riskier (patent threat on its major drug Plavix with expected peak sales of EUR 5-6bln) Sanofi-Synthelabo (SAN FP; EUR 59) looks attractively priced after this year's sharp decline. The stock is stuck in a trading range of EUR 53 - 65. We would use any weakness closer to EUR 55 to buy the stock for a rally to the mid-60s, which is a conservative level, in our view.

With no patent threat issues, Novartis (NOVN VX; CHF 59.70) remains the safe bet in the industry. However, due to its strong outperformance versus the sector (down 0.5% year-to-date while the sector has lost 25.54%) it might underperform the sector when the sentiment improves. We would be buyers at around CHF 56/57.

The better than expected US jobless claims and French unemployment rate caused Adecco (ADEN VX; CHF 52.70) to gain 10% after reaching a new 12-month low on Wednesday. The two markets are the company's core markets next to the UK. The stock has been battered over the past weeks as US and European economic data seemed to imply a further deterioration of the economy. Under the assumption that global economies start improving over the next 12-18 months and companies start hiring Adecco will benefit first as temporary staff will be used to manage the first leg of a pick-up. We believe that the stock is attractively priced at current levels and reiterate our buy recommendation for investors with an investment horizon of 12-18 months.

Vivendi Universal (EX FP; EUR 13.01) updated the market on its further plans to reduce its EUR 19bln debt pile and the new strategy after the ousting of former CEO Messier. Overall, the presentation did little to strengthen the low credibility the company currently enjoys among investors. Lot of blame was apportioned on the previous management, which led to the resignation of six board members yesterday. The new management was firmly committed not to pay any severance package to Mr. Messier. In terms of business news the company finally announced the sale of its Italian assets Telepiu for approx. EUR 1bln to News Corp., which is about EUR 500 million below the earlier price tag.

CEO Fourtou's remarks 'we are a media company. This is a fact. We realise that our credibility to manage these assets is close to zero' sounded little convincing and left the impression that Vivendi Universal has become a media company because of unfortunate developments rather than due to a clear strategy.
There was little news regarding further asset sales. The company reiterated its plans to exit the publishing business but left questions about Cegetel (the French telecom company) and Vivendi Environment unanswered. The good news was Vivendi Universal's plans to reduce its debts by EUR 13bln to EUR 6bln by the end of 2004, which is 4bln more than initially planned.
Due to the lack of strategy as well as lack of opportunities the company has on its hands, we remain very cautious on the stock.

Nokia (NOK1V FH; EUR 14.50) was the bright spot in the technology sector gaining 10% for the week. Nokia benefited after RF Micro Devices, which supplies semiconductors to Nokia upgraded its 2Q02 profit and sales forecast. Additionally, the head of Nokia's US business said at a conference that he expected industry sales to increase between 10% and 15% next year. He expects the replacement market to pick up, as operators will be able to offer new and fast services. These statements are not new and remain controversial since networking companies reiterate that investment spending is further declining. Nokia made it clear that these were not official company forecasts. Nokia gained 10% yesterday.