Negative sentiments prevailed in Europe and the Euro STOXX50 closed the week 5% lower (page 1 of 3)

US Markets

Since the beginning of the year, defence sector has outperformed the market. The S&P 500 Aerospace & Defense index lost 9.78% YTD while the S&P 500 lost 30.27%. We still believe the sector should outperform the index for the whole of 2002, especially stocks with significant exposure to the defence industry. We believe a likely war with Iraq and high defence expenditure should continue to support stock prices. However we would not recommend buying into the sector at current valuations. We would rather wait for further possible weakness before investing. Despite a weak commercial business, which limits upside room, defence companies' stocks trade at significantly high valuations.

General Dynamics (GD, $81.64, CSFB recommendation: Neutral) remains our favourite in this sector due to lower valuations than its competitors. Currently, GD's P/E ratio is at 17x while the sector trades at 20x. The company is one of the best-managed defence contractors, with a strong position in ships, combat vehicles and electronics/information systems. GD's defence business accounts for 61% of 2002 profits (source: SG Cowen). Despite weak demand for its business jets (Gulfstream), the stock price is expected to rise in 2003, thanks to improving defence profitability. Furthermore, we believe in a possible rebound in demand for its Gulfstream jets in late 2003-2004 period. For the short-term, we believe the stock price will remain under pressure due to weak civil aviation business and a $2.3 billion repayment to the U.S. Navy, together with Boeing Co. In 1991 when the A-12 fighter-bomber program was cancelled, both companies never paid back $1.3 billion received as progress payments and $1 billion in interest. They missed the payment deadline on September 30th, 2002. The Defense Finance and Accounting Service were told last Wednesday to take "action as is appropriate". So far, we do not know the kind of action the U.S. Navy will take against the companies. However, we believe that the measures will not be drastic enough to pose any significant threat.

Further to what was mentioned above, Boeing Co.'s (BA, $32.01, CSFB recommendation: Outperform) stock price should remain low and volatile. We believe current stock price is principally representative of BA's defence business. Despite BA's business mix shifting towards defence and aerospace and at the same time generating strong growth, the commercial aircraft business still represents 47% of 2002E BA's EBIT (source: Banc of America Securities). Tensions between Iraq, further airline bankruptcies, and a union negotiation representing the engineers in December would limit the short-term upside. We maintain our hold recommendation.

According to the research firm Thomson First Call 53% of the 1045 companies that provided a mid-quarter update for Q3 announced that they would miss analysts' estimates, 24% said that they would meet them and 23% would beat them. These downward revisions point to a reduction in the S&P 500 earnings growth forecast for the quarter to 7.1%, down from a 16.6% increase that was expected in August, according to a First Call poll.

The earnings revisions affected all the sectors and there is no real trend detectable as to which sectors would be spared the decline. Again this demonstrates how important stock picking is in the current market. The macroeconomic picture however impacts the IT sector quite hard and we do not see acceleration in spending on IT by corporations in the near term. The low earnings visibility and the uncertain economic outlook are very likely to contribute to further delays in the deployment of large IT projects.

After the sell-off over the past three sessions, a strong short-term rebound is not implausible as we could see some short covering.