Dow rally best for 20 years

USA

The DJIA posted the strongest weekly gain in 20 years last week. Friday's rally was supported by news that coalition forces are in charge of airfields and Iraqi leaders had lost control and that some were surrendering.

Amid rumors of Saddam Hussein's wounding or death, there was speculation his regime might capitulate in days. Stocks of companies that use much oil in cost structure rallied strongly. Airlines and chemical makers were among the strongest performing groups on Friday.

Last week, four investment houses reported their 1Q earnings results that were well above expectations. Stronger than expected fixed income trading and underwriting income drove the surprise. The brokerage group has outperformed the S&P 500 and S&P Bank Index during the latest market rally as well as the year to date period.

While strong fixed income related businesses should continue to support earnings for the brokerage group, a potential pick up in equity related businesses could drive additional earnings in the short term. If Gulf War 1 (Kuwait invasion) is a guide, current military action in Iraq could cause a strong rebound in equity deal activity.

According to Dealogic and Prudential Securities, there was $13 billion in equity origination in the six month prior to Iraq's invasion of Kuwait. In the subsequent six months, deal volume dropped by more than half to $5 billion. However, during the six month after U.S. dropped its first bomb on Iraq in 1990, equity deal volume jumped to $35 billion in the period.

There is a P/E expansion potential for the brokerage group. The group's ROE fell to around 11% in 2002. On the downside, we do not expect the ROE to sustain below 10%because brokers can use compensation as a lever to maintainROE above 10%.

But on the upside, if financial activities pick up, ROE could return to a normal range of 14-16%, supporting higher P/E for the group. In fact, based on the latest 1Q results, Goldman Sachs and Lehman Brothers have already shown improvement in ROE to 13.7% and 13.9% respectively.

While May oil futures collapsed from $37/barrel to $27.5/barrel since March 12, the Amex Oil Index rose 4.7% during the same period. This is not unusual given this diverging trend also happened in 2000 and 1998. While supply concern remains on Iraqi War, demand outlook may not be as bad as some suggests.

Firstly, U.S., which represents near 25% of world oil consumption, may need to replenish its substantially below normal inventory. Secondly, Japan, the second largest oil consuming country, will shut down many nuclear power stations this spring as a result of the TEPCO accident potentially increasing oil demand in the near term.

The third demand driver is from China. China's oil consumption has been increased 250% from 1990 to rank third in the world in terms of oil consumption. We expect strong growth in oil demand from China in coming years because of strong China economic growth outlook.

Europe

European markets followed U.S. markets to rally strongly last week, posting their biggest weekly gains in 18 months on anticipation of a quick Iraqi War victory by US-led forces.

Looking ahead, apart from war, focus will likely be on several business confidence surveys. According to Bloomberg, economists expect little change to Germany IFO that will be released on Wednesday.

Italy and France are scheduled to release business confidence figures on Tuesday and Thursday respectively. Market expects slight decline for both surveys. Other focus will be on earnings results for several reinsurance companies. Munich Re, world's largest reinsurance company, and Swiss Re will report their earnings on Thursday.

Japan

The Nikkei rebounded but underperformed global indices last week. The concerted war-relief rallies around the globe helped pulling Nikkei up from a multi decade low.

We attribute the underperformance to the problem of North Korea, disappointing government policy and concerns about stock valuation losses. North Korea, one of three 'evil country' described by the U.S., may continue to post geopolitical risk to North Asia.

The appointment of Fukui as new BOJ governor disappointed some foreign investors because of his lack of strong support for inflation targeting.

The recent sharp decline in bank stocks has led a number of companies to announce downward earnings estimate revisions, mainly as a result of widening valuation losses on stockholdings.

Looking ahead, stronger overseas markets should improve sentiment for the local markets. However, the trend of foreign investors selling could continue to cap any strong gains ahead. Foreign investors, who account for near half of trading share in TSE, have been net sellers in the past three weeks