Not a lot of surprises expected

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. Carolina, which traditionally has the highest level of per pack profitability, saw this figure drop 23% to $0.54 from a year ago.

Management has indicated that it intends to continue with the current level of promotional spending given the absence of a material change in overall competitive conditions.

We would like to highlight that Carolina remains in a league of its own in terms of per pack profitability We have been through the numbers and spoken to various analysts and have come to the conclusion that this quarter's results are not indicative of anything operationally unsound.

We continue to view CG as attractive given its niche within the menthol segment, superior per pack profitability and healthy and safe dividend yield of 8.4%. Carolina will remain on our US recommendation list and is consistent with our thematic approach to US equities of Market share gainers, Energy plays and High Dividend yields

European equities

The DJ EUR Stoxx 50 closed the week slightly down at 2460.14
 Weak results from chemical sector
 Energy sector upgrades coming through and support our two oil stocks Total and ENI
 Update on Adidas-Salomon

On the economic front, last week's data continue to point towards stabilisation, however, the improvement in sentiment has not yet filtered through to the real data.

German unemployment rate remained unchanged at 10.6% and the German industrial output decrease in June was probably strike related. German order intake surprised on the positive side, however most of the increase was driven by foreign orders intake.

Italy was the first EU country to report 2Q GDP figures on Friday. Italy - Europe's fourth biggest economy - has entered into a technical recession after having reported two consecutive quarters of contraction. This week, Germany and Euroland will report its 2Q GDP figure on 14th August, and are expected to reflect subdued activity.

The week was overshadowed by weak results from the chemical sector, which shows that tough trading conditions continue to persist. Bayer's (BAY GR; EUR 19.05) operating result was below estimates due to the weak performance of the Agrochemicals and Polymers divisions.

BASF (BAS GR; EUR 39.93) result were in line on an EBIT level, but only due to 'others' items and not due to operating performance. Both of them gave cautious outlooks. Given high raw material prices and the still subdued demand we would avoid the sector for the time being.

European oil companies managed to report positive 2Q results driven overall by high oil price, which allowed them to generate extensive cash flows. Consensus estimates for the majors look to be on an upward bias.

On Friday, Citigroup raised the energy sector from underweight to overweight based on attractive valuations (sector PE03 of 10.8x resulting in a relative PE of 88 whereas the sector's historical average was between 78-130) and the significant underperformance of the mega cap stocks (underperformance of around 12% since beginning of the rally mid March).

Given that five of the largest fifteen stocks in Europe by market capitalisation are energy stocks any catch up of performance will likely favour them. Citigroup's upgrade supported the already strong weekly performance of the sector and lead it to close over 4% higher against a flat overall market.

With a weighting of 7.7% Total (FP FP; EUR 135.90) has the biggest weighting in the DJ Euro Stoxx 50. We expect Total to outperform when further upgrades of the sector come through. Total ended the week 5.6% higher. Total's 2Q results were broadly in line with consensus estimates.

Whereas higher oil and gas prices had a positive impact, the stronger Euro offset some of this increase. Despite lacking exposure to rallying US gas prices, clean net income was up 42% in USD versus an average of 46%. Oil production grew by 5% and the rate was also confirmed for the full year, which reflects faster growth than some of its competitors such as BP and Shell.

ROCE at 18.9% is top quartile, cash generation remained strong and share buy-back is ongoing. With an indicative dividend yield of over 3% Total fits nicely into both our 'energy' and 'dividend yield' themes. We reiterate our buy for an investor with a long-term view.

Our other energy cum dividend yield play is ENI (ENI IM; EUR 13.438). Solid production growth of 6% makes it one of the fastest growing oil companies. Indicative dividend yield is around 5.6% and valuations remain attractive on a PE03 of 10.4x.

Adidas-Salomon (ADS GY; EUR 70.39) reported solid results. Sales figures came in slightly below expectations however 2Q net income rose 27% yoy. Gross margins remained stable at 44.8%. A further positive was also that the earnings growth forecast was maintained at 10-15% for the full year and for currency adjusted sales at 5%.

After Nike pointed to weakness from US retailers in the 1Q and Adidas-Salomon announced a 10-15% decline in end June US backlogs at the Munich ISPO trade fair, we believe the 12% decline in North American order backlog was already priced in by the market.

Whereas we consider this a temporary market weakness and not company specific, we would expect the solid sales in Asia and the stronger than expected sales and margins in Europe to offset it on an overall basis. Europe order backlog increased by 10% and the company sees European sales increasing more than expected for the full year.

With the strong Euro the company is losing on the translation effect, however in the mid to long-term there is a counterbalancing element as the cost of their mainly Asian production is expected to go down. We reiterate our buy.