The re-insurers Munich Re and Swiss Re dominated news flow in the insurance sector

US Equities

• Recommendations update

Since the start of the War in Iraq, investors have cast aside economic data and corporate fundamentals. As President Bush said, the war could be longer and tougher than previously expected. We think news flow from Iraq will continue to lead investor sentiment for the coming weeks.

Hence we would like to reiterate our positive stance on our recommended defense contractor, Northrop Grumman Corp. (NOC, $86.46, CSFB: Outperform). Firstly, the company has successfully built and realigned its business mix to become a critical and broad-based systems supplier to the Pentagon, becoming the third-largest defense contractor, behind Lockheed Martin Corp. (LMT, $48.14, CSFB: Outperform), and Boeing Co. (BA, $26.10, CSFB: Outperform) in term of revenue. Secondly, the sale of TRW Automotive would be used to reduce its outstanding debt, improving its return on capital. TRW Automotive was sold on March 3rd to The Blackstone Group for $4.7bn. However, integration of recent acquisitions could cause further stock price weakness. Thirdly, NOC acts as a primary contractor or as a subcontractor to the major new weapons programs. Hence, with the increase in US defense spending, expected to continue for several years, we believe NOC would benefit from its wide range of competence. Finally, the stock price presents two advantages for good portfolio diversification, in our view. On the one hand, the beta vs. the S&P 500 is low (0.27), which would act as a cushion against price volatility, and on the other hand, correlation with the same index is negative, which would dampen the impact of a declining US market. BUY.

Besides Northrop Grumman, we maintain our Buy rating on Countrywide Financial Corp. (CFC, $57.91, CSFB: Not rated) for the following reasons. Stock price has a low beta vs. the S&P 500 (0.74) and a low correlation with the index. On the business side, the MBA refinance index remains high at 8,136 as of March 21st, hence as the volume of mortgage refinancing remains high, it would generate higher servicing portfolio fees, protecting earnings from a potential downturn in the mortgage origination cycle. In FY 2001, these fees accounted for about 30% in total revenue. Another hedge is the non-mortgage operations, which accounted for 21% of CFC's consolidated revenue in FY 2001 (source: Countrywide Financial). The risk for the coming weeks is that, if the war on Iraq continues for longer than expected, mortgage origination could decrease sharply. However, we do not think this decrease would occur. Federal Reserve is expected to reduce interest rate, which should give another boost to mortgage refinancing.

As near term uncertainties continue, we believe it would be a safe move to lock in profits on some of our recommended stocks.

Two examples of stocks which had seen no weakness over the last week are the integrated oil company Exxon Mobil Corp. (XOM, $36.03, CSFB: Neutral) and the drug maker Pfizer Inc (PFE, $31.81, CSFB: Outperform). Both companies' fundamentals are sound, which actually supports the steadily rising share price, and we also are comfortable with our long-term projections and valuation models for the two companies.

Exxon rose 14% from its 27th January low at $31.58 to $36.03 last Friday. In our view, in the current environment trading oriented investors should consider locking in some of their short-term profits in Exxon at these levels.

Similarly Pfizer, whose share price rose from levels around $28-29 and is now hovering around $32, offers a potential 10% short-term profit for its investors. Nevertheless, we still believe the long-term prospects for remain intact.

For investors, wanting to park their Exxon Mobil and Pfizer gains elsewhere, the gold mining stock Placer Dome Inc (PDG, $9.64, CSFB: Outperform) offers a good opportunity to reinvest profits.

The gold price is recovering from its recent weakness, as investors are starting to buy into the commodity again with equity markets tending weaker. Furthermore, Placer Dome's competitor, Newmont Mining Corp (NEM, $26.59, CSFB: Neutral), having recently posted sound results, should help to boost the sentiment toward the sector.

On Altria Group (MO,$32.13, CSFB: Not Rated), our take is that there has been an immense knee jerk reaction in the market on the back of the US$10bn award on Friday. MO still has grounds to appeal. The case was tried in a Madison county court. The next stage would be the Illinois Supreme Court. Failing that, it goes to the US Supreme court. The case is ultimately very weak and we believe should not be able to stand up to appeal. Even the Illinois Attorney General has been widely quoted in the news as being highly critical of the bonding legislation. We will be downgrading MO to a hold due to near term volatility. Maintain our belief that legal risk Profile of US Tobacco industry is in secular decline. We will shortly be putting out a more detailed note.

European Equities


• The DJ EUR Stoxx 50 closed the week 5.2% lower at EUR 2132.11

• The re-insurers Munich Re and Swiss Re dominated news flow in the insurance sector.

After the ZEW Index (sentiment survey among institutional investors and analysts) rose unexpectedly in March on the back of the rate cut by the ECB and German Chancellor Gerhard Schroeder's announced cuts in welfare, the IFO index (key German business sentiment index) was unable hold up and declined to 88.1 from February's 88.9. Concerns over geopolitics and uncertainty over the duration and outcome of the Iraqi invasion continues to hurt sentiment. As the conflict is now set to drag on for longer than expected, weaker confidence increases the risk of damaging the underlying activity. As a consequence, investments might be postponed for even longer.

After the recent run-up in stocks on the back of expectations of a short and easy war, sentiments turned around this week and investors became more cautious as they realized that the Iraqi invasion might take longer than planned. As a consequence, the more defensive European sectors outperformed this week with Food & Beverage, Energy and Utility and Telecom sector outperforming the broader market. This fortifies our long-term stance to focus on defensive dividend playing stocks.

The insurance sector - one of last week's underperformers - was once again in the spotlight. Munich Re (MUV2 GR, EUR 59.12) and Swiss Re (RUKN VX, SFR 70.75) posted disappointing results, but the latter lifted markets when it said it expected a return to profitability in 2003. Munich Re posted a record EUR 2.2bn loss in the 4Q. Writedowns on investments totalled EUR 1.4bn. Full year profit came in at EUR 1.1bn, but was short of analysts' expectations. Although reinsurance premiums climbed 14.6% to EUR 25.4bn in 2002 and the price trend can be expected to be positive, further writedowns on investments should not be ruled out, especially in the first quarter. Although the group announced the reduction in its various equity stakes such as Allianz (ALV GY, EUR 50.00), Hypovereinsbank (HVM GR; EUR 7.35) and Commerzbank (CBK GR; EUR 6.60), Munich Re has yet to clarify whether and how it plans to fundamentally reshape its portfolio of shareholdings. The stock closed the week 28% lower. We continue to remain cautious on Munich Re as we prefer to wait for the company to decrease its equity portfolio and bolster its capital position. With regards to the insurance sector in general, we do not recommend buying into the sector, as we do not see the fundamentals improving in the medium term.

Swiss RE closed the year with a narrower than expected net loss(CHF 91m). Premiums climbed 15% to CHF 29.1bn boosted by the acquisition of life re-insurer Lincoln Re as well as by the favourable condition of the property and casualty reinsurance business. In contrast to its competitors, Swiss Re has no plans to raise capital, however it cut its dividend to CHF 1 per share from the CHF 2.50 per share. The stock closed the week around 1% higher.

The ECB is meeting this week and will decide on any additional rate cuts. We believe, it is likely that the policymakers prefer to wait until the geopolitical situation becomes clearer before their next step is taken.