We believe there is a potential for earnings downgrades in 03

US Markets

• Recommendation update

Since October 10th, diversified financials have outperformed the market. The S&P 500 Diversified Financials index had a total return of 28.50%, while S&P 500 had a total return of 15.98%. Concerns related to headline risk and high consumer credit seem to have faded in investors' minds, hidden by the falling unemployment rate. However we would be more cautious, believing these risks remain, and we would not recommend the sector. Firstly we believe that the outlook for U.S. economy remains uncertain. Retail sales were mixed in October. The Department of Commerce reported that U.S. retail and food services sales fell to $301.7 billion, virtually unchanged from September, but down 0.7% y-o-y and below consensus forecasts of a 0.2% decline. One the one hand, motor vehicle sales declined 1.9% m-o-m due to the lack of new incentives offered by auto dealers. On the other hand, retail sales less autos rose 0.7% in October. The sudden spell of cold weather across the U.S. gave clothing sales a boost of 4%. Gasoline stations also did well (1.5%), and non-store retailers increased 1.4%. Secondly we think consumer credit should weaken in the near-term as banks tighten their credit standards (source: the Federal Reserve's 'October 2002 Senior Loan Officer Opinion Survey on Bank Lending Practices'). 10% of banks surveyed tightened credit standards for approving mortgage loans, 15.2% of banks tightened credit standards for approving applications for credit cards and 14.9% of banks tightened credit standards for approving consumer loans. It is important to note none of the banks surveyed eased credit standards. We believe this is a good move for credit quality and competitive intensity. Finally we think it likely that several periods of profit taking should occur, putting pressure stock prices.

We maintain our hold recommendation and long-term view on Citigroup Inc. (C, $38.54, CSFB: Outperform). We believe Citigroup will remain under pressure from negative news, eroding investors' confidence. Several lawsuits have still not been resolved (e.g. Enron, WorldCom) and conflicts of interests between banking and research businesses could bring further surprises. On the business side, we are positive on the company. Product mix should protect company's earnings from volatility.

Mortgage companies should maintain good momentum, even if rising delinquencies in this segment could pose problems for some companies. We would rather focus on companies with well-diversified businesses, maintaining our buy recommendation on Countrywide Financial Corp. (CFC, $51.45, CSFB: Not covered). The bulk of its earnings come from mortgage origination fees and other fee income, which made up over 70% of 2001 pre-tax earnings, while earnings from mortgage-related investments were 28% in 2001.

The Nasdaq Composite Index saw a rally over the second half of the week, as Hewlett-Packard (HPQ, CSFB: Neutral) issued positive guidance during its earnings release. While we remain cautious on the outlook for the computer related stocks like Hewlett-Packard, we do not share management's optimism, especially since the numbers it reported wee more the product of cost cutting than top line growth.

But in order to ride the rally in the technology stocks, which we believe still has some momentum left in it, we recommend the small cap entertainment software maker THQ Inc. (THQI, $17.95, CSFB: Outperform). THQ makes game software for PC and consoles like the Sony Playstation or Microsoft's Xbox. This is a trading recommendation for aggressive investors, as the company being a small cap could see high volatility in its share price. The stock recently came under pressure, as the company reduced its 2003 revenue growth forecast to 11-15%, from a previous 20-25%. The sell-off in the stock has resulted in attractive valuations and we believe offers a good trading opportunity. With a price to book of 1.68x, a price to sales of 1.55x and a expected 2003 price earnings ratio of 14.45x, the stock more than prices in the lower growth rate. We believe the stock should be fairly valued at $22. The stock should also profit from the fact that the Christmas period is seasonally the strongest for entertainment software.

Fundamentally however, the outlook for technology stocks is not terribly bright. The book-to-bill ratio, which is a principal indicator for the semiconductor industry, but which also gives an indication of the overall price of broad areas in the technology sector, fell to 0.73 in October, from the 0.80 on month earlier. This is the fourth consecutive decline and is due to an 8% decline in bookings. It will be very important to follow the bookings over the next couple of months, especially given the latest rally in chip stocks. The divergence between the semiconductor companies share prices and the underlying fundamentals has been increasing and could lead to a correction, if semiconductor equipment bookings do not catch up, signalling a up trend in the cycle.

European Equities

• The Euro STOXX50 closed the week 4.4% higher at 2648.14. The highest closing in the last ten and a half weeks.

• We would lock in a 9.8% profit on Adecco as the stock reached our target price since our trading recommendation. However, we will leave the stock on our long-term recommendation list, as we believe the company is well positioned to benefit from an improvement in the economy.

• Despite our trading call, our fundamental stance remains unchanged in that we believe there is a potential for earnings downgrades in 03. We would focus on defensive companies, which provide a reasonable dividend yield.

In the short term we expect the improving sentiment for an earnings recovery next year to provide good support for equities. Additionally, window dressing before the year's end might also positively impact stocks.

In line with our momentum driven trading call initiated on Thursday, we would like to highlight that it is very important that investors exercise discipline to execute stop-loss and profit-protection levels. We played the trading call in the following three ways:

1) Leveraged, high beta stocks such as AXA (CS FP; EUR 15.85), BNP (BNP FP; EUR 45.59), Nokia (NOK1V FH; EUR 18.98), Infineon (IFX GR; EUR 10.22) and Adecco (ADEN VX; EUR 61.00).

We would now take a 9.8% profit on Adecco as the stock has reached our target price since our trading call recommendation. Please note that we will keep the stock on our long-term recommendation list as we continue to believe that the company is well positioned to benefit from an improvement in the economy.

2) We would recommend selected telecom stocks such as Vodafone (VOD LN; 127p), which is more a momentum rather than beta plays after the sector reported relatively decent results.

3) Buy the index. CSAM launched an Exchange Traded Fund (ETF) - XMTCH (Lux) on MSCI Euro (XMMSE SW; EUR 76.10) - in October, which tracks the MSCI Euro. This index provides a diversified exposure to around 120 companies.

Having said this we are not changing our fundamental stance on European equities yet as we believe valuations still have room to improve especially in the light of potential downgrades for next year's earnings. We continue to focus on companies that generate solid cash, offer defensive and predictable earnings visibility and good dividend yield. Stocks such as these will outperform the market in the coming months in our view.

According to data released by Frank Russell the telecom sector still belong to the three most underweight positions held by investors. In addition, we see the fact that telecom are among the three out of 18 sub-sectors that are currently enjoying earnings upgrades, an encouraging development, which supports our view that telecom operators will focus on profitability going forward. It is worth mentioning that most European telecom operators have new management in place with a clear mandate to reduce debt and to return to profitability, rather than to continue the expansionary strategy of previous management. Investors with a longer-term investment horizon should start building up positions in this sector, with Vodafone being our core investment recommendation

Further supporting the telecom and telecom equipment sector was Nokia's (NOK1V FH; EUR 18.98) statement that handset sales in the years up to 2005 will grow between 10%-15%, which has led to rumours that Nokia was about to increase its target for next year's global handset sales.

We would also like to point out that the recent gains of companies in the mobile network infrastructure sector such as Alcatel (CGE FP; EUR 5.65) and Ericsson (ERICB SS; SEK 10) have been too strong, too fast. So far, there are no signs of improvements in the industry yet as telecom services providers are still reducing capital spending for the coming year. Reducing positions or writing calls on core holdings would be an appropriate strategy going forward for this sector.

MAN (MAN GY; EUR 13.29) reported a net profit of EUR 26 million, which was slightly below expectations. Since there was no pickup in demand MAN had to reduce its full-year pre-tax target to last year's level compared to earlier expectations of a gain. However, the fact that there were no new surprises is good news for MAN. The company had to take big charges earlier in the year (Arianespace and Fairchild Dornier) and we expect this benefit to feed through next year, which is in line with the company's statement stating that is expecting 'strong improvement' in 2003. Most importantly, MAN's valuation does not require star performance. As these restructuring benefits start to feed through, MAN does not need revenue improvement to increase margins significantly in 2003. In view of next year's improvements we remain positive on the stock but believe that investors do not need to rush into the stock until there is evidence of an economic recovery.

On Tuesday after the market closed TotalFinaElf (FP FP; EUR 136.3) reported a positive set of 3Q figures, which were in line with market expectations. Clean net income came in at EUR 1,600m for 3Q (9% down yoy). However, as a company reporting in Euros, the 10% appreciation of the Euro vs. the dollar served to distort the results. In USD terms, TotalFinaElf actually reported a 4% increase in clean earnings vs. an average 14% decline for its peers. In fact it was the best 3Q earnings performance of the European oil majors measured in USD. Lower margins in refining and marketing were offset by stronger oil and gas prices. We continue to believe that oil stocks TotalFinaElf provide a good portfolio hedge given the current geopolitical risks, but are aware that the sector is likely to underperform if markets were to rally further from here.