Markets fuelled by wild speculation (page 1 of 2)

US equities

One of the main characteristics a stubborn bull run in a secular bear market is the frustrating ability of investors to completely ignore the bad news, and last week was a case in point.

We believe that market rose last week due to nothing more than wild speculation and short covering. Key economic data would suggest that the rally was completely unjustified.

One of possible catalysts for last week rally could have been better than expected ISM data suggesting a pick up in manufacturing and services sector of the US Economy. However, was the positive surprise ISM data actually much to write home about?

We do not believe so. According to Merrill Lynch's US Strategist, the "prices paid" component of the overall index has a very has a very high correlation to the S&P 500 EPS growth. The "prices paid" component had its biggest drop in 30-years.

This appears to be yet another profits indicator suggesting that the profits cycle might be peaking, and that second half earnings might be weaker than many have suggested. Not to mention the unemployment rate, which came in at a nine year high of 6.1%.

Aluminium maker Alcoa Inc. (AA, $24.61, CSFB: Not rated) continued to see its share price rise over the last week, as aluminium traded strongly. News on the company's activity also helped to boost the stock.

Alcoa announced that it sold its Latin American plastic bottling business to Amcor Ltd, for $75 million. The deal comprises nine plants in Brazil, Argentina, Colombia, Peru, Uruguay and Chile, which supply plastic bottles to companies such as The Coca-Cola Co and PepsiCo Inc.

Divesting these non-core assets should also help Alcoa improve its profitability further, while increasing its focus on the aluminium business. The company in fact said last Friday it planned to invest USD 2.7 billion in Brazil over the next seven to eight years in its existing operations in order to double capacity and in the same time cut production cost. A part of the investment will be for new power generators, to make the company less dependent on third party producers, which has led to a 15% production cut in Alcoa's Brazil operations, as the government rationed power in 2001.

Alcoa's capital expenditure plans also include investments of USD 6-7 billion worldwide from 2004-2010 for factories and hydroelectric plants to run them. But the main focus for growth for Alcoa are Brazil and China, where power is cheaper, as energy is an important cost factor in the aluminium production.

We believe that Alcoa's continuous restructuring and refocusing strategy, and also the investment strategy would help the company to fully benefit from the growth of a new cycle in the aluminium industry.

Last week we also added Harley Davidson Inc. (HDI, $44.53, CSFB: Outperform) to our US recommendation list. HDI has good fundamentals with a low level of indebtedness (20%) of total assets).

We view HDI as a good prospect for investors with a long-term view. The dividend discount model suggests a theoretical price of $60 (source: Bloomberg). We expect the 100th anniversary of the company to boost sales. Finally, being unique, and with its well-recognised brand, we believe the company has strong pricing power, which would allow the company to generate earnings growth despite the weak economy.

European equities

Business software maker SAP (SAP GR, EUR 107.09, CSFB: Neutral) saw its share price surge on Friday, after Oracle (ORCL made a $ 5.1 billion hostile take-over bid for its competitor Peoplesoft (PSFT).