Relief brought by the war

US Equities


• Recommendations update
S&P 500 increased 7.5% last week on optimism that a war in Iraq will be short. Hence, for investors who want to play this short rebound, we added the Bank of New York Co. Inc. (BK, $22.20, CSFB: Restricted) on our recommendation list with a Buy rating. Correlation with the S&P 500 is at 0.94 and beta is at 1.35 (source: Bloomberg). In January 2003, BK agreed to purchase CSFB's Pershing unit for $2bn in cash. Pershing is the largest global provider of correspondent clearing services and outsourcing solutions for asset managers, brokers, and other financial intermediaries (source: Bank of New York). The theme is on an increase in trading volumes. However investing in BK remains risky due to further writedowns of loans, and a weak equity market, which could have a negative impact on BK's Asset Management unit.

With the beginning of the war in Iraq, volatility in aerospace & defence stock prices increased significantly. For last week, S&P 500 Defence & Aerospace index volatility rose to 29.00, while average volatility since the beginning of the year reached 22.00 for this index (source: Bloomberg). Besides volatility, pension expenses for 2000-02 could still add pressure on defence contractors' stock prices. The majority of defence companies use multiyear smoothing function of asset returns. Hence variation in pension income affects earnings for several years. So far, among large defence companies, only Boeing Co. (BA, $28.10, CSFB: Outperform), and Raytheon Co. (RTN, $27.78, CSFB: Outperform) have provided explicit 2004 pension expenses. Boeing estimates that pension expense will decrease to $75 million (about $0.094 per share) in 2003 from $404 million ($0.36 per share after-tax) in 2002, then to a $175-300 million ($0.22-0.38) expense in 2004. Raytheon estimates that pension expense will move to $295 million in 2003 ($0.49 per share) from $89 million in 2002 ($0.15), and then increase to a $618 million ($0.97) in 2004. Our recommended defence contractor, Northrop Grumman Corp. (NOC, $82.35, CSFB: Outperform), is the one of the few companies that does not smooth its pension returns. Therefore, all of the underperformance in the plans for 2000-02 is already reflected in its figures. As a result, we maintain our Buy rating on NOC. For investors looking for yield, we believe the 7% Northrop Grumman preferred shares could be interesting. The shares are convertible until April 4th, 2021 at a ratio of 0.9111. The current price is $122.

The drug maker Pfizer Inc. (PFE, $31.96, CSFB: Outperform) is getting closer to finalising its planned acquisition of its competitor Pharmacia Corp. (PHA, $44.45, CSFB: Outperform). Pfizer is selling several of its products in order to comply with agreements reached with the European Commission and the US Federal Trade Commission, as these drugs would compete with drugs in Pharmacia's portfolio or would give Pfizer a dominant position in one therapeutic area. The divestitures involve mostly minor products, which will not have a material effect on Pfizer's earnings, as the main focus remains on the synergies that the integration of Pharmacia into Pfizer's operations will generate and as a consequence strengthen the company's profitability further. Both companies will have consolidated sales of around $45 billion and a research and development budget of $7 billion. Pfizer expects to achieve $2.5 billion in annual cost savings by streamlining its businesses.

The finalisation of the acquisition will certainly strengthen Pfizer's position and should over time be reflected in the share price. Currently valuations remain attractive, given the company's solid growth perspectives. The stock is trading on a slight premium to the S&P 500 in terms of its expected 2003 full year earnings (PFE: 17.8x, S&P 500: 16.8x), but given the good earnings visibility and growth perspective, there is still some upside potential in the share price. The relatively low patent expiry risk and sound risk diversification thanks to the broad product portfolio and pipeline should also add to the positive sentiment towards the stock, once the acquisition is finalised.

Investors who have bought Pfizer following our recommendation could however consider taking some of their profits, as the stock could possibly tend weaker in the very short term, due to profit taking activity after the 10.4% share price increase over the last five trading sessions.

We have re-added the gold mining stock Placer Dome Inc. (PDG, $9.05, CSFB: Outperform) to our US Buy List, after the stock declined since our profit taking at $10, due to weakening gold prices. But as the war in Iraq continues and if it proves to be more drawn out than anticipated, gold prices should start rising again, which would be supportive for the share. We believe the ongoing economic uncertainties and geopolitical issues, accentuated by the conflict in Iraq, could serve to drive gold prices higher. The recent weakness in Placer Dome's share price offers a very good buying opportunity for trading oriented investors, seeking an investment in gold or a proxy for gold, and who would like to capitalise on the higher volatility of the gold mining stocks compared to an investment in the gold bullion.

Europe

Europe Equities

• The DJ EUR Stoxx 50 closed the week 8.15% higher at EUR 2249.11

• We recommend to lock in any profits made during the recent run-up and lighten up on high beta stocks to focus on defensive, dividend playing stocks

In Germany, the ZEW Index (sentiment survey among institutional investors and analysts) rose unexpectedly to 17.7 in March compared with 15 in February and an expectation of 12 for March. It is the third month the index has sequentially increased. The rate cut by the central bank beginning of March and German Chancellor Gerhard Schroeder's announced cuts in welfare last Friday might have helped sentiment this month. However, it should not be forgotten that the strong Euro will hurt German exporters and although the announced cuts in welfare are the biggest in the last two decades they might not be enough to get the structural reforms running.

Among corporate news flow this week, was the offer from Procter & Gamble (PG US) of a 22% premium (EUR 92.25 per share) for the 77.6% of the ordinary shares (or 50.7% of capital) the Stoher Family owns in Wella (WAD GR; EUR 90.31). The total sum paid will be EUR 6.5bn. With the acquisition, Procter & Gamble will increase its market share in the hair care cosmetic industry to 18.2% versus L'Oreal's (OR FP; EUR 60.65) 15.3% share. Therefore, it could be expected that competitive pressure on L'Oreal will increase.

Another event, eagerly anticipated by the insurance sector, was Allianz' (ALV GY; EUR 60.65) results announcement. Allianz reported a net loss for 2002 (EUR 1.2bn), a cautious but slightly more optimistic outlook for 2003 and various measures to strengthen its capital base.

The performance in the insurance business showed stronger than expected premium growth but a write-down of EUR 5.5bn was necessary due to weak capital markets. Dresdner bank itself recorded a net loss of EUR 1.4bn and was the main reason for the group's overall weak performance.

The announcement to raise EUR 5bn in new capital increases fears of further rights issues in the sector. Allianz plans to do a rights issue to raise EUR 3.5 - 4bn and in addition they plan to issue a convertible of EUR 1.5bn. The crossholding of Munich Re and Allianz will be reduced from around 25% to around 15%. Although the capital increase is a long-term positive, we expect the stock to remain under pressure in the medium-term. We remain cautious on Allianz. The stock is very much geared towards the performance of the European market in general and the German market in particular. We would like to see a stabilisation of the fundamentals in the market and a reduction of the various interests Allianz holds in several companies outside its core business before we turn more positive.

JCDecaux (DEC FP; EUR 9.20) released strong results with a net income increase of 155% to EUR 26.0m in 2002 (CSFB estimate EUR 14.5m). EBITDA margin in the group's street furniture business reached 40.6% (CSFB 39.9%).

These results are very comforting as they clearly show that the company's street furniture business has not suffered at all from the current advertising slump. The shares have been weak over the last two weeks on the back of uncertainties regarding the advertising market and the opening of a judicial enquiry in Belgium. We believe the reaction has been overdone and remain confident on JCDecaux. They are the leader in street furniture, which offers high visibility and high margins.

SAP (SAP GY; EUR 79) was impacted by results from its US competitor Oracle. The headline level of Oracle's result was in line to slightly better than expected but the weakness in license revenues especially in Europe and the uncertainty reflected in the outlook weighed on the stock. SAP remains attractively valued in a global context and although the stock could remain under pressure in the short-term, we remain positive on its long-term prospects.

LVMH (MC FP; EUR 41.50) was impacted after the Swiss luxury good company Richemont (CFR VX; CHF 20.25) came out with a profit warning. However, it has to be noted that Richemont with its higher exposure in jewellery and watches is a more cyclical play than LVMH with its relatively larger exposure to leather goods. We remain positive on the stock as we believe that the company has proved that the luxury goods business can resist an economic downturn.

Vodafone (VOD LN; GBP 1.215) increased 20.3% since the beginning of the pre-war rally on 12 March and shows a YTD performance of 7.28%. In order to protect our downside we will shift our stop-loss from GBP 0.95 to GBP 1.15.