Not a lot of surprises expected (page 1 of 3)

US equities

On the market side, we do not expect a lot of surprises. We believe markets would remain uncertain, as investors take profits after the recent rally, counterbalanced by macroeconomic data showing a U.S. economy in mild recovery. Hence we would recommend investing in corporates with strong balance sheets. We would also favour companies with strong growth prospects.

We believe Johnson Controls Inc. (JCI, $96.49, CSFB: Not rated) fits into both categories. Firstly, at the end of FY2002, the company had borrowings representing only 18% of total assets, and a free cash flow growing at an average rate of about 14% p.a. for the last 5 years. Secondly, sales grew at an average rate of 12% p.a. in the same period.

Furthermore, JCI reported a better-than-expected $2 EPS for 3Q, up from $1.85 a year ago, and sales increased 13% y-o-y. Excluding a shortfall in orders from the automobile industry, which we do not expect due to a diverse range of customers, we believe JCI's shares offer a good way to reduce portfolio volatility. Therefore, we maintain our Buy rating on Johnson Controls.

The healthcare sector, namely pharmaceutical stocks have been lagging the S&P 500 year to date (S&P500: +12.30%, S&P Pharma: +3.41%), due to weakness in share price since mid June. Thus valuations in some of the stocks have become very attractive.

In times of broad equity market weakness the healthcare sector, thanks to its defensive growth characteristics has performed relatively well, and we believe this could be the case over the medium to long term.

Also reviewing the last earnings season and focusing on valuations and long-term outlook, our attention falls on selected pharmaceutical companies and healthcare related stocks. We believe that the sector should regain investors' favour after it declined sharply in the first half of 2002.

Patent expirations, fewer new drugs coming to market and pricing constraints have put pressure on the pharmaceutical industry. This has given the sector certain cyclicality.

However fundamentals remain solid. With a compound pipeline of over 1,100 drugs, according to the Pharmaceutical Research and Manufacturers of America (PhRMA), the industry's growth has not come to a halt. The ongoing ambition to better understand diseases by developing drugs with fewer side effects has made research and development more expensive.

This could lead to a new wave of mergers and acquisition, similar to the 1990's. Pfizer, with its acquisition of Pharmacia has potentially set the first milestone

Stocks that we recommend in the sector are the drug maker Pfizer Inc (PFE, $32.97, CSFB: Outperform), Merck & Co Inc (MRK, $55.59, CSFB: Neutral), the medical companies Johnson & Johnson (JNJ, $51.75, CSFB: Not rated) and Abbott Laboratories Inc (ABT, $39.90, CSFB: Not rated), as well as the wholesale drug distributor Cardinal Health Inc (CAH, $58.95, CSFB: Neutral).

Our two new additions from the pharma sector last week were Merck & Co and Abbot Laboratories. We see the two stocks as attractively valued long-term investments especially with regard to their dividend yield of 2.66% for Merck and 2.46% for Abbott Laboratories.

Carolina Group (CG US, $21.80, CSFB: Not Rated) reported disappointing 2Q03 results. EPS of $0.72 was significantly below consensus forecast of $0.97. The principal culprit for the shortfall was increased promotional spending during the second quarter.

This has been the first earnings disappointment posted by Carolina since its IPO in January 2002.