Markets fuelled by wild speculation

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).

Since Peoplesoft itself had announced three days earlier that it planned to acquire its smaller rival J.D. Edwards (JDEC) for $1.7 billion in stock, there has been a speculation of a wave of M&A activity among the major business software makers. It is uncertain how far this would go, but so far a possible acquisition of Peoplesoft by Oracle could be positive for SAP over the medium term.

As Oracle said it would migrate Peoplesoft customers onto the Oracle platform over time, giving SAP the possibility to enter into the Peoplesoft installed base. SAP could face strong competition in its core business, if Oracle adopts its aggressive price discounting policy for the Peoplesoft products

DaimlerChrysler AG (DCX GR, EUR26.67, CSFB: Outperform) saw its shares decline last Wednesday as the company announced that it would not meet the forecasted $2 billion in operating profits in its Chrysler division. The company said that Chrysler would lose about $1.17 billion, due to lower revenues. The company has been giving large discounts in order to revive sales of its Sebring sedans and Voyager minivans, but the extent of the impact of these discounts on Chrysler's earnings was higher than expected, and a setback for Chrysler.

While the company was hurt by the strength of the EURO, it is mainly the price war in the US automobile business, which continues to hurt the results. Chrysler is continuing to fight against a decline in market share, after it slid to 13.4% from the year earlier period, where the company recorded a 13.9% market share.

As a result of the loss at Chrysler, the company as a whole should see its full year operating profit fall to about EUR 5 billion from last year's EUR 5.8 billion. While in April the company was still projecting the 2003 operating profit to be slightly higher than last year.

The share price of DaimlerChrysler recovered form the sell-off, showing that an investment in DaimlerChrysler continues to be a recovery play and therefore requires a long-term investment horizon, as there could be a bumpy in the medium term. We however, remain positive on the stock, in so far it does not seem that the dividends are in jeopardy, which should provide a certain price support with the stock having an indicative dividend yield of 5.72%.

CSFB reduced its sales forecast for Sanofi-Synthelabo's (SAN FP, EUR 53.10, CSFB: Neutral) blockbuster anticoagulant drug Plavix. CSFB is raising fears that Sanofi's patents on the drug might come under threat, as generic drug makers could start challenging them. Plavix is Sanofi's second largest drug, which according to analyst could become a EUR 6 billion drug by 2006, from the EUR 3 billion in total worldwide sales expected for the current year, and one of the major growth drivers for the company.

Therefore the threat from potential generic competition could be a major risk to Sanofi. But as the main patents on Plavix should be valid until late 2011, which leaves Sanofi the time to harvest the fruit of its drug discovery. However the legal battles challenging the validity of these patents could start earlier than that, leading to strife for Sanofi.

In the meantime Sanofi is expected to continue to see solid growth rates. The company recently also has launched new products, which should be able to sustain Sanofi's long-term growth. The cancer drug Eloxatin, which was launched in 2002 for colorectal cancer could receive approval for ovarian cancer as well and become a major drug for Sanofi. We maintain our valuation model on Sanofi-Synthelabo as well as our buy recommendation.