War and upcoming quaterly results to add to market volatility

US Equities


• Recommendations update

Uncertainties coming from the war in Iraq after US troops entered into Baghdad would still have a major impact on the market in the coming week. However, companies would soon report their quarterly figures, which would add market volatility. Hence we would like to highlight some recommendations, which offer good portfolio diversification.

Firstly, Johnson Controls Inc. (JCI, $75.67, CSFB: Not rated), our recommended automobiles components company, should continue to outperform this industry. We believe, with its wide range of customers, like Ford Motor, General Motors, DaimlerChrysler, Honda, Interstate Battery Systems of America, John Deere, Mazda, Mitsubishi, Nissan, Peugeot, etc, the company should be relatively sheltered from a decline in auto sales in the U.S. Furthermore, JCI's two-year correlation with the S&P500 is at -0.114 while its beta is at 0.93 (source: Bloomberg). Hence we maintain our Buy on JCI.

Secondly, Countrywide Financial Corp. (CFC, $59.37, CSFB: Not rated) stock price also indicates a negative correlation with the S&P 500 (-0.756), and a low beta (0.75, source: Bloomberg). Last week, in order to protect our profits since our recommendation of the stock at $50.55, we increased our stop-loss level to $55, which secures an 8.8% gain on the stock. We believe CFC would continue to report strong mortgage loans origination for the first quarter 2003. Hence we reiterate our Buy recommendation on Countrywide Financial. The risk for CFC is a possible downturn in the cycle. However, servicing portfolio fees, and non-mortgage operations, which represented 27% of CFC's pre-tax earnings in 2002, should protect earnings from high volatility.

Finally, Northrop Grumman Corp. (NOC, $83.26, CSFB: Outperform) should continue to benefit from US defence spending. We believe this trend would continue this coming couple of years, as President Bush has asked for a $74.7 billion supplemental spending bill from US Congress. The latest defence budget left over from the Clinton administration stands at $291 billion. Two years on, if this supplemental spending is included, the FY03 budget will be about $430 billion. Although this supplemental request will be mainly absorbed by the personnel, operations and maintenance accounts, we believe defence companies would also benefit from a potential increase in new weapons programs. We have a Buy rating on NOC.

The pharmaceutical sector recently has come back into favour. We believe one reason is the defensive characteristics of this industry, but also the weak sector performance over the previous three months. This has led to bargain hunting in the sector. Our favourite stock, which we recommend to buy, is Pfizer (PFE, $32.80, CSFB: Outperform). We like the company for its solid growth outlook and the benefits of the acquisition of its competitor Pharmacia Corp (PHA, $44.80, CSFB: Outperform), which is expected to be finalized by the end of this month.

Major oil companies, including our recommendation Exxon Mobil (XOM, $35.52, CSFB: Neutral) are likely to be involved into rebuilding the Iraqi oil industry, according to the early talks that are held between US officials and Iraqi exiles, which could be placed into power after a defeat of the current Iraqi regime. It is estimated that approximately USD 5 billion would be needed to restore the production capacity of 3.5 million barrels a day that Iraq had before the sanctions were enforced after the first war. This would give these companies access to the important Iraqi oil reserves and would for these companies mean a new opportunity for long-term growth.

We have downgraded our recommendation on Altria Group (MO, US$28.30, CSFB: Neutral) from BUY to HOLD. Our new target price is now US$40 with a stop loss level of US$27. Our change in view has come on the back a US$12bn bond Philip Morris USA will have to post in order to appeal against an adverse verdict. We believe ultimately PM USA will prevail, but in the near term, MO's stock price will be at the mercy of news flow pertaining to litigation. The company has quite a number of appellate options to go through before any payment would be made. We believe that at this point PM USA is right in making a stand. Any form of settlement at this point would be an open invitation for future claims. In any case there is a considerable amount of pressure from 49 other states on the Illinois legislature to reduce the bonding requirement. Under the Master Settlement Agreement of 1998, the States had agreed that US Tobacco companies would have to pay US$245bn over a certain time period. Now with the Illinois bonding requirement, the amount due to the States is in jeopardy. At a time when the other States are struggling to balance their budget, we believe that they will not be willing to forego any form of payment. There are a considerable amount of hurdles MO has to surpass at this point, but we believe it to be likewise for the plaintiffs.

European Equities


• The DJ EUR Stoxx 50 closed the week 4.3% higher at EUR 2223.17

• Vodafone is approaching GBP1.25 - 1.27 and we would advise investors to take partial profit once these levels are hit.

The week was guided by macro themes and geopolitics rather than stock specific news. After the rapid approach towards Baghdad and less than expected resistance, hopes returned that the war would be over soon. This development on the geopolitical front overshadowed a further fall of business and consumer confidence in Euroland in March (business: -12 from -11 in February, consumer: -21 from -19 in February). Several other economic indicators such as the Euro Manufacturing PMI, French Consumer Confidence and German Retail sales also pointed to sustained weakness in the underlying economy.

Despite the further deteriorating indicators, the ECB left interest rates unchanged at 2.5%. Inflation for March was still at 2.4% which is above the official target of 2%, however taking into account the higher oil price, the core rate would come down below 2% and would have given way for further action. According to ECB President Wim Duisenberg, a decision to cut rates would only be likely if there were an urgent need to inject liquidity due to the prevailing turbulence in the financial markets. The Central Bank seems to prefer to wait in order to estimate the full impact of the war. Given that economic impetus in the euro zone is both sluggish and on the wane again, and in light of the ongoing strength of the Euro and a favourable inflationary outlook in the medium term, we still expect the bank to act in its next meeting. Market consensus expects a further 50bps rate cut by the middle of this year.

European markets remain very volatile. According to a recent study by SSSB, a 1% daily move in the DJ Stoxx is now four times as common as in the mid 1990's. On a stock level, around 20% of the DJ Stoxx has been moving by over 5% a day over the past month. This recent increase in volatility can not only be blamed on the Iraq crisis, but indicates more of a structural shift. Hedge funds, retail investors, shortening of time horizon and international capital flows have all played their part.

Interesting to note is that on a sector level, Insurance has taken over from TMT as Europe's most volatile sector, also some of the more consumer cyclical sectors such as auto and retail are becoming increasingly volatile. On the other side, telecom and technology are the only two sectors where there has been a fall in volatility this year.

Vodafone (VOD LN; GBP 119.5) announced that it also got control of Telecel after it had gained control of Libertel and Europolitan earlier on. Vodafone now has 94.4% of Telecel and can apply for a squeeze-out to the minorities. CSFB estimates that the impact of buying in the minorities of Libertel, Europolitan and Telecel could add 1-2% to Vodafone's EPS for the year to March 2004. However, Vodafone has still to make an offer for its remaining quoted affiliate in Europe, Panafon. We remain positive and we would advise investors to take partial profit when the stock is approaches GBP 1.25 -1.27, which is around 5% away from current levels.

SAP (SAP GY; EUR 74.89) went through a volatile week. After the stock came under pressure at the beginning of the week as an independent survey showed that more than half of the companies using its software did not achieve a positive return on their investment (a report which SAP referred to as unrepresentative and unscientific). The stock jumped over 9% on news that they will work with China's Neusoft Group to tap into the fast growing market.

Peoplesoft pre-announced their 1Q results last Thursday night. License revenue declined 36-40%yoy and the numbers confirmed that what results of Oracle and some smaller companies have already shown is more a market than a company specific issue. Given that SAP's multiple tends to expand and contract with upgrades and downgrades and CSFB estimates that SAP's 1Q license estimates of EUR 280-300m would lead to a full year consensus EPS falling 10-15%, the current 21.5x 03 multiple will also contract to closer to 17-18x. Therefore, we believe that the stock will come under pressure in the short term. Please note SAP is due to report 1Q figures on 17 April.

In the current environment, we would like to reiterate two of our themes: dividend play and energy. A stock, which nicely combines the two, is ENI (ENI IM, EUR 13.391). CSFB reiterated its positive view on the stock and forecasts a 33% upside to their Economic Value Added derived fair value. After ENI reported 4Q results, which were in line with CSFB's expectations, the stock relatively underperformed as the gas & power division slightly disappointed. However, part of the margin compression in this division stems from ENI's decision to renegotiate distribution contracts in 2002, which is a smart move comparing it to British Gas, which tried to maintain high margins for as long as possible until the regulators stepped in. We also continue to like ENI's strategy of redeploying capital from low into high returning businesses, which are mainly upstream. The 6% production target was extended a further year to 2006 and alongside TotalFina (FP FP; EUR 124.5) is the highest volume growth target of any of the major integrateds. In addition, ENI comes with a dividend yield of over 5.5%.