Market actiivity cools off a bit

USA

On Friday, despite encouraging Chicago PMI and personal income data, profit warnings from Sun Microsystems and Bellsouth dampened investor sentiment.

Market has entered the 3Q pre-announcement season. Market appears nervous that negative surprises will again dominate the market. Since 3Q of 2000, actual quarterly earnings were mostly below estimates at the start of the quarters due mainly to analysts' over-optimism.

However, unlike previous two quarters, analysts have been more willing to revise down their 3Q and 4Q earnings growth estimates (q/q). Since the start of the year, the estimated 3Q earnings growth of S&P 500 has been revised down from near 30% to fewer than 15% now while 4Q estimated growth has dropped from over 40% to fewer than 25% now.

It is difficult to predict whether these drastic adjustments are enough, but current 3Q estimated earnings growth for the technology sector (61%) appears high.


Secondly, the potential for net interest margin contraction over the medium term is increasing owing to the prospect of tightening interest rates (though possibly delayed due to U.S. economic weakness) will likely flatten the yield curve (BOC has raised its lending rate by 25 bps at each of its last three meetings).

Trading at a discount to domestic banks, insurance stocks appear more attractive, given the resilient earnings demonstrated during the second quarter.

For this week, focus will be on the Bank of Canada meeting on Wednesday.

Europe

European stocks caught up with U.S. markets' correction and finished the week much lower.

European insurance stocks underperformed last week after Swiss Reinsurance reported much weaker-than-expected results and Munich Reinsurance scrapped its previous earnings forecast. Both companies are suffering from the tumbling stock markets that forced them to write down large amount of investments.

The major setback last week was the German IFO survey, which fell disappointingly to 89. The figure suggested that the pace of recovery is slower than the early-1990. For example, the IFO survey rose from 90 at the beginning of 1993 to 100 by the end of 1994.

Thus far in the recovery of 2002, the IFO has risen from 85 to 92 and is now back at 89. This should create doubts to analysts that are predicting a normal recovery in profits, increasing the probability of more earnings downward adjustments.


Japan

The Nikkei has been trading in the range of 9,500-10,100 for nearly a month and could not break through resistance despite gains in the U.S. markets during the same period. We believe cross-share holding sales, which are typically heavy in August, have added extra weights.

We also expect supply/demand balance should improve starting in September. However, entering the pre-announcement season, potentially weak overseas markets may drag down the Nikkei in the near term. Funds flow have not been encouraging as foreign investors, who account for near half of total trading share, continued to be net-sellers in the past four weeks.

For value investors, valuation for Japanese stocks appears attractive. The 10-year JGB yield fell below 1.2% last Thursday for the first time since June 2001. The simple average prospective dividend yield for the First Section of the Tokyo Stock Exchange stood at 1.3%, suggesting equities are undervalued.