ECB and Bank of England left interest rates unchanged as expected

Stock Market

• Recommendation update
Last week, Countrywide Financial Corp. (CFC, $54.01, CSFB: Not rated) reported December 2002 operational results. The company reached a new loan funding record in December of $35.2 billion, the figures were $32.2 billion in November, and $34.7 billion in October. For 2002, CFC funded $251.9 billion in mortgage loans, increasing its 2001 record by 63.5%. Refinancing activity fuelled by low interest rates has been the primary driver for loan funding activity over the last two years. We believe low interest rates should continue to drive purchase-funding volume. Servicing portfolio followed the up-trend; it grew to a new record level of $452.4 billion, representing a 3.9% rise from November, and a 34.4% rise y-o-y. We maintain our Buy rating on Countrywide Financial due to its diversified businesses. This should reduce the risk of the cyclicality of the core mortgage business. Securities trading volume was $175.6 billion, representing a 39% increase y-o-y, and insurance recorded 4.2 million policies in force vs. 3.3 million in 2001. Next week, CFC is expected to publish its 4Q results. Consensus is expecting $1.905 EPS, increasing by 9.48% m-o-m, and by 65% for the full year.

Boeing Co.'s (BA, $33.85, CSFB: Outperform) stock price should remain under pressure for the coming months due to built-in pessimism. On one hand, the downtrend in commercial aviation should continue in 2003. For the coming year, the company expects 275-285 commercial aircraft deliveries, while it delivered 381 aircraft in 2002, representing a 28% decrease from 2001. This segment should continue to add volatility to BA's stock price. On the other hand, military aircraft segment revenues rose 14% in 3Q'02, and space & communications division revenues rose 2%. We expect this trend to continue as long as government spending on defence remains strong. We think current stock price does not take into account BA's commercial aviation business and possible signs of a recovery in civil aviation.

Next week, the company will make public its 4Q'02 results. Consensus is expecting $0.707 EPS, increasing from $0.46 in the previous quarter. However, we maintain our Buy rating on Boeing, believing current valuation presents a good entry level for the long-term. The current stock price is lower than its theoretical price of $43.45, derived from the dividend discount model.

Spot gold price continues to remain firm above $350 an ounce, with some spikes towards the $357 levels. We expect gold price to continue to stay close to these levels, as the current economic and political uncertainties continue to dampen the market. Gold and therefore the gold mining industry still offer very attractive opportunities for investment and diversification. We believe that a gold mining stock is a good way to invest in gold, as it tracks gold price quite closely. It however, shows a higher volatility, which is related to the profitability of a gold mining company as a function of the gold price. As the production cost for gold is relatively high, the profit margins are relatively narrow. Placer Dome (PDG, $11.71, CSFB rating: Outperform), the gold mining stock that we recommend as a BUY, outperformed the gold spot price by 4% since we added the stock to our recommendation list on August 30, gaining 17.45%.

The company has continuously reduced its hedged positions, by 20% over the year, and is now gives a more sensitive to movements in gold price. At the time when we added the stock to our buy list, it traded at a discount to its two major US competitors, Newmont Mining (NEM, $28.61, CSFB rating Neutral) and Barrick Gold (ABX, $15.66, CSFB rating: Outperform), due to its copper assets. We believe that with copper prices close to its historical lows, the risks are limited and with the recent acquisition of Aurion Gold in Australia, the exposure to gold has increased further. In fact, since we added Placer Dome to our buy list it outperformed both its competitors by 16.9% and 19.3% for Newmont Mining and Barrick Gold respectively.

Meanwhile Placer Dome's copper assets are becoming increasingly interesting, as copper price begin moving up. It is difficult to evaluate just how far they could rise in the current environment, but there should be more upside in the medium term. Trends would support such a rise, given that copper consumption is rising, namely in China. According to a study done by the International Copper Study Group, as of September the global copper supply deficit was at 18,000 tonnes due to an increase in demand from China by 19.9% year on year.

We continue to monitor developments in the copper industry closely and continue to view Placer Dome as attractive as an investment in gold, but increasingly as a copper play as well, if the trend in copper prices and consumption continues.

The oil and oil service sector has seen quite an eventful start to the New Year, with the West Texas Intermediate (WTI) flitting between $30 and $33 at the New York Mercantile Exchange (NYMEX). Disruptions in oil supply from Venezuela to the United States has caused the price to rise, due to the fear that the US crude oil inventory situation might become tight, especially with the latent risk of a military intervention in Iraq.

OPEC had decided last Sunday to raise its output by 6.5% to 24.5 million barrels a day, in order to compensate for the supply disruption from Venezuela. It will probably not make crude oil prices move significantly lower, as it does not fully compensate the disruptions in Venezuela. As a comparison, in December Venezuela produced 700,000 barrels a day, down 2.28 million barrels from its November production of 2.98 million barrels a day before the strikes broke out. However this increase in OPEC output could prevent oil prices from rising further. For the time being it doesn't look like the political situation in Venezuela is going to improve any time soon. Therefore we do also not expect the oil exports to return to normal in the near term.

With crude oil prices staying close to $30 a barrel, the current environment continues to be favourable for the oil and oil service industry. Exxon Mobil (XOM, $35.24, CSFB rating: Neutral), our top pick for the integrated oil companies, along with Noble Corp (NE, $34.25, CSFB rating: Neutral) and Schlumberger (SLB, $41.77, CSFB rating: Neutral), the two recommended oil service stocks should continue to perform well over the near term. They should soon recover from an increase in US oil inventories recently published in a report by the US energy department. This drop would actually offer a good buying opportunity, especially for the two oil service companies.

We would like to highlight that Philip Morris (MO US, $41.20, CSFB: Not Rated) and Carolina Group (CG US, $21.80, CSFB: Not Rated) have both appreciated 8.3% and 18% respectively since initiation. As we had highlighted in the note, both stocks were recommended principally for their high dividend yields. However, we feel we cannot ignore an 18% rise in the price of CG and would urge investors to take partial profit on the stock, but to maintain part of their initial investment in the stock, as we still believe both of our tobacco recommendations to be primarily yield plays. MO and CG currently yield 6.2% and 8.2% respectively.

Europe Equities

• Stay with defensives such as pharmaceuticals or selected telecoms which is one of the few sectors with positive earnings momentum

• SAP's earning's pre-announcement surprised the market - SAP remains our favourite European play in technology

The first full trading week in Europe was overshadowed by several profit warnings coming from the insurance Britannic (BRT LN, GBP 1.635), airline KLM (KLM NA, EUR 9.00) and retail sector Dixons (DXNS LN, GBP 1.205). Given the current uncertain environment and the still high earnings expectations, we believe there is potential for further disappointing news which will continue to put pressure on the corporate sector. One way to distinguish between 'good and bad' is to observe earnings momentum, which had a powerful effect on relative performance trends for most of 2002 according to CSFB. The telecom sector is for example one of the few sectors, which saw their forecasts begin to rise towards the end of last year. On the other hand, technology stocks saw the pace of downgrades in the 4Q drop. However, it remains to be seen if this represents a genuine turning point or a result of the strong performance seen in the October/November rally. Defensives (except beverages and food retail) continue to show relative earnings robustness.

The ECB and the Bank of England left interest rates unchanged as expected. In the ECB Press Conference it was reiterated that 'the current monetary policy stance is appropriate to maintain a favourable outlook for price stability in the medium term.' However, we believe that once it becomes evident that inflation is well below the target rate of 2% which CSFB expects to come through in published CPI data by May, the ECB will have more room to lower rates.

Aventis (AVE FP, EUR 52.95) won the FDA panel's support of its antibiotic Ketek. Ketek is a drug used against respiratory tract infections and it is expected to have peak sales of USD 1.5bn by 2010 and contribute 5-8% of its operating profit by 2007. Ketek has already gained approval in the EU and several Latin American countries. It is expected that the FDA will approve the drug later in the year giving Aventis the possibility to compete in the US antibiotic market. Ketek has a success rate of about 85 to 90%, a figure comparable to widely used drugs such as Abbott's (ABT US, USD 39.78) Biaxin and GlaxoSmithKline's (GSK LN, GBP 12.42) Augmentin.

We remain positive on pharmaceuticals as the sector currently trades on a slight discount to its five-year average relative PER which makes it one of the most attractive valued defensive sectors on this basis. In addition, relative earnings have been robust. We believe current fears of patent expiries have been overdone. Aventis remains one of our top picks in this sector.

Vodafone (VOD LN, GBP 1.22) denied any near term intention of a sale of its stake in Verizon Wireless and for a bid for Voicestream (owned by Deutsche Telekom). Verizon Wireless is a JV between Vodafone and Verizon Communications whereby Vodafone holds 45%. Any potential sale and bid for loss-making Voicestream could be value-destroying for Vodafone. We believe it is more likely that Vodafone would swap some of its stake in Verizon Wireless for Verizon's minority stake (23%) in Italy's Omnitel.

With the appointment of the new CEO and the first phase of the put option exercisable from July onwards we expect to hear more of such reports and expect the stock to be volatile. We would use any pullback as a buying opportunity.

Telecoms are the only European sector with the 12 months forward earnings revision ratio improving and we believe Vodafone is a solid industry play on a sector-wide recovery in margins.

While reporting worldwide 2002 vehicle sales, Peugeot (UG FP, EUR 40.42) and Renault (RNO FP, EUR 45.55) gave a bleak outlook for 2003 vehicle sales, which they expect to be flat to slightly down. Although this is no new news it pulled the auto sector lower. DaimlerChrysler also announced that it has to increase its pension costs by EUR 700m due to further deterioration of the financial markets in the fourth quarter. CSFB has already accounted for this amount in its valuation model. Investors with a 12 - 18 months time horizon should use the current weakness in DaimlerChrysler (DCX GY, EUR 29.76) to buy as nothing has changed in our investment case for DaimlerChrysler, which is based on valuations and benefits of the restructuring.

SAP (SAP GY, EUR 93.74) rose over 9% over the last 5 trading days and closed on Friday above its 200-day moving average. The good performance was partly driven by the pre-announcement of their 4Q results. SAP stated that 2002 sales will increase slightly from a year ago and that it will meet its profitability target, meaning that operating margin excluded stock-based compensation and acquisition related charges reached 21% despite the poor market climate. These positive comments are mainly based on its license revenue which is expected to be EUR 950m in the 4Q 02 exceeding analysts' expectations by 15%. According to CSFB, if 4Q 01 results are adjusted for the effects of 9/11 then license revenues in 4Q 02 rose 2% yoy, which is the first time SAP has had positive revenue growth in 5 quarters. The final quarter usually accounts for around one third of annual license revenues and one third of annual total sales.

Although 2002 was a difficult year for all software vendors, SAP managed to outperform its peers and gained market share from competitors such as Oracle, mainly due to its significant installed base and its ongoing cost reduction exercises. The overall picture for a substantial improvement in demand might still be gloomy, but we believe that there is room for discretionary spending by companies for new software applications. The pre-announced numbers also imply that the US, which used to have slower growth and lower margins compared to other regions, must have been performing well in the 4Q which is very encouraging. SAP remains our preferred European technology play. CSFB estimates that the current stock price only implies around 11% long-term growth, which is at the bottom of the historical range of 15-20%. Given the potential for further margin improvements, this may be too low.