Uncertainty and nervousness likely to remain high (page 1 of 3)

US Equities
Among our recommendations, Countrywide Financial Corp. (CFC, $53.16, CSFB: Not rated) The stock has a beta of 0.76 vs. the S&P 500. In the last quarter, the company reported an EPS of $1.94 in 4Q02 vs. consensus expectations of $1.922, driven by high loan production volume. Besides, we believe CFC's diversified business should protect earnings from volatility. In 4Q02, diversified operations represented 28% of CFC's pre-tax earnings. Management clearly said its goal to increase diversified operations to 50% until 2006. We expect Countrywide would outperform the market in the short-term, as long as rates remain stable, and U.S. mortgage origination does not drop quickly. The mortgage origination pipeline was down in December from November, but the company indicated that January mortgage applications are running higher than December. Hence we reiterate our Buy rating.

On February 3rd, President W. Bush unveiled its $380 billion FY 2004 budget proposal for the Pentagon. This represents a $15 billion increase from 2003 budget (source: JP Morgan). Major segments to benefit from this increase are ammo (+9% vs. 2003), and shipbuilding (+10%), while missile funding went down 10%. Among our recommendations, General Dynamics Corp. (GD, $65.75, CSFB: Outperform) had about a 30% exposure in shipbuilding in 2001. However we maintain our Hold rating on GD due to its business jet unit. We think this segment could generate further pressure on stock price. In 2001, GD's business jet sales represented 27% of total revenue (source: Bloomberg).

Currently we prefer Northrop Grumman Corp. (NOC, $91.69, CSFB: Outperform). NOC is a pure defence play and after the acquisitions it made in the last few years, the company should be well positioned to reap the benefits from the increase of technology in the army. Furthermore, like GD, Northrop Grumman has also exposure to shipbuilding, which represented 14% of NOC's total sales. On February 13th, the company will hold an investor conference. We do not believe the conference will throw up anything new, but a confirmation of a positive outlook for 2003. We maintain our BUY rating on the stock.

The oil sector saw quite an eventful week, with crude oil price moving up to over $35 a barrel for the West Texas Intermediate, pushed up by the war rhetoric from US President George W. Bush and Secretary Of State Colin Powell. This rise in oil prices has already started to build in a possible war premium that would result in the event of an attack on Iraq by the US. The situation however seems to ease partly, after Russia said it would back the plan by France and Germany to send more US weapon inspectors and also UN peacekeeping forces in Iraq. The three countries are backing each other to avoid a military intervention and give more time to the weapons inspectors. The tone has certainly risen and as a result we expect volatility in crude oil prices to remain high.

In the meantime, Venezuela's output is steadily rising, almost unnoticed, as the country continues to build up its production following its national strike. Venezuela's Energy and Mines Minister Rafael Ramirez said the country's output is 1.9 million barrels a day, a third of its regular production. The longer the delay on any attack on Iraq, the more time Venezuela has to get back to its old production levels. This would also help to ease the pressure on the crude oil side.

We expect the oil and oil service stocks to continue to follow the movements of the crude oil price and remain volatile.