Terrible times for global markets

USA

The selling on Friday nearly erased all the gains markets
made during the mid-week rally on back of earnings
assurance from several blue chips companies and technical
reasons gave. Friday saw stocks being pressured by
concerns about earnings quality at General Electric, profit
warnings by Philip Morris and Wyeth, as well as steep job
cutbacks at SBC Communications.

For this week, short-term technical indicators suggest that
stock markets should likely continue the process of testing
late-July/early-August lows. Sentiment would stay subdued until concerns about profit warnings dissipate. We expect volatility to stay high with important economic data (ISM manufacturing) and potentially more political news (attack on Iraq) driving market sentiment.

However, the medium-term outlook may not be as bad as
recent market actions suggest. Although September was
again a down month, as it has so often been in the past, there is a positive side - we are into what has been an
anomalously strong seasonal period.

In the past 14 years, the DJIA posted gains 12 times and the S&P 500 rose 11 times between the start of October to the end of December, suggesting overly pessimistic towards the year end is not warranted. Another positive is that the market, comparing to July-low and Sept-11 last year, has fewer stocks trading at new low. In the July-low and Sept-11 last year, around 800 stocks in the NYSE made new low.

Despite Friday's big sell-off, less than 100 stocks made new lows in the NYSE, indicating market breadth has improved. In addition, valuation measures give support. According to the Fed valuation model, which compares the benchmark bond yield to forward earnings yield, stocks are 35% undervalued as of last Friday.

In terms of strategy, short-term uncertainties keep our focus on consumer staples stocks. Their earnings stability often attracts safe heaven buying in times of high market
volatility.

Canada

The current economic condition is a rare exception compared to other G7 economies. After August job data boosted expectations earlier this month, housing starts surprised the market with a 6% m/m gain, compared to expectations of a decline. 2Q capacity utilization rate came in a full percentage point above expectations at 83.2%, highest since 2Q01.

However, market has focused on future prospects given August's lower than expected leading indicator (+0.2%). Consensus EPS for 2002 for the TSX is expected to drop once negative pre-announcements from Nortel and Barrick Gold, two heavyweights in the index, get fully integrated into the index consensus numbers. In the short-term, we prefer staying on the sideline as a result of potential profit warnings heading into October. Tonight's GDP and Thursday's department store sales are the focus.


Europe

European markets performed mixed with German markets
underperforming. The better than expected job data and PSA Peugeot Citroen's plans to increase sales by 23% by 2006 helped support the French market. However, the German market is likely to stay weak owing to the bleak economic outlook. Although September IFO index came out slightly better than expected, it is down from August figure.

There are increased concerns over domestic demand in the Eurozone. In the U.K. and U.S., consumption growth forecasts for 2002 have improved, but forecasts for Germany and Italy, two of the big three economies in the Eurozone, have fallen quite dramatically.

This weakened outlook may cause more earnings estimates downward revisions in the short-term. However, attractive valuation may offer some support to the markets going forward. According to Bloomberg, the DJ Euro Stoxx index (Eurozone) trades at 16x estimated 2002 EPS.


Japan

Long-term credit, regional, and city banks sold a net JPY970 billion between April and the first week of September. At this pace, the banks might fall short of their planned annual sales of cross-shareholdings of JPY4.8 trillion.

Overall, the BOJ plan to purchase bank stocks directly from banks should diminish the negative supply impact on banks crossshareholdings sales. Therefore, the market's supply/demand position should improve in coming weeks. It is expected that Koizumi's administration will respond positively to BOJ's decision by speeding up bad-loan disposals. Comprehensive measures are expected by the end of October.

For long-term value investors, Japanese stocks appear attractive on a dividend yield basis. Although the simple average prospective dividend yield for the First Section of the Tokyo Stock Exchange is only at around 1.1%, the real yield is among the highest in global markets given Japan's negative inflation and extremely low interest rates. In the past 12 years, the dividend yield has exceeded 1% on three previous occasions, in 1998, 1992 and 1995. The stock market bottomed out on all three occasions.

Compared to the benchmark bond yield, the relationship appears even more extreme. When dividend yield was last at this level, in 1992, JGBs yielded 4.8-5%. Although corporate profits and economic outlook are weak, the possibility of massive
dividend cuts should not be big (except bank) because
companies have paid out only a modest amount of net profit as dividend in the last 10 years and have been under
pressure to increase their payout ratio.