A more positive outlook for global equities

US equities

Last Friday, the U.S. equity market slid as higher sales forecast from Intel Corp. (INTC, $27.39, CSFB: Not rated) failed to alleviate concern that shares already reflected a recovery in the economy and profits.

The market was also led down after Schering-Plough Corp. (SGP, $14.96, CSFB: Underperform) cut its dividend by 68% to $0.055 a share and predicted a drop in next year's profit (source: Bloomberg). This decrease erased the gain during the week, with the S&P 500 remaining virtually flat. For the coming week, we remain cautious, believing weak corporate fundamentals would limit the gains driven by signs of an economic recovery in the U.S.

Therefore we took profit on stocks that rallied, such as Illinois Tool Works Inc. (ITW, $71.57, CSFB: Not rated) and Harley-Davidson Inc. (HDI, $49.36, CSFB: Neutral). We secured a 14.29% return on ITW and 17.15% on HDI since our recommendations on May 23rd, and June 2nd respectively.

We also closed our trading recommendation in PMC Sierra Inc (PMCS, $12.99, CSFB: Not rated), which hit our target price of $13.50 intraday, yielding a profit of 12.22% since recommendation on August 19, and in Cardinal Health Inc (CAH, $57.84, CSFB: Neutral), which recovery rally appeared to run out of steam, taking a 9.74% profit since August 1st.

We continue to recommend investing in laggards with attractive valuation, like The Allstate Corp. (ALL, $36.20, CSFB: Outperform), whose stock price underperformed the market. Since July 1st, ALL's stock price decreased 1.84%, compared with the S&P 500 Insurance Index, which gained 2.24%.

In the near term, ALL would benefit from a tight personal lines market, and an eventual rebound in the consumer-based financial services market. Company's strategic goals are to grow its property/casualty business and to broaden its presence in financial services offerings for middle-income Americans, and it is gaining ground on both fronts (source: Prudential Financial).

For trading-oriented investors, we added General Electric Co. (GE, $29.88, CSFB: Neutral) on the U.S. Recommendation List as a play on a possible increase in orders for power transmission equipment after the blackout in the northeastern U.S.

We fixed a tight stop-loss at $28.00. Economic environment remains difficult for GE, which reported a 0-5% decrease in July short-cycle orders. They were down 5-10% excluding acquisitions and currency. CSFB expected a 10-15% increase (up 0-5% excluding acquisitions and currency) on a reported basis.

Reported orders appeared to decelerate from June results, which were up 10-15% (Source: CSFB). Plastics sales in July were hurt by sluggish demand from automotive end markets as many U.S. auto manufacturers shut down for an extra week in July to work off inventory (source: Deutsche Bank).

The medical company Abbott Laboratories (ABT, $38.98, CSFB: Not rated) plans to spin off most of its hospital products business to focus on its faster growing drug and medical-devices units. Hospital products contributed to 17% of Abbott's fiscal 2002 revenues and to 18% of the operating earnings.

But since the launch of the rheumatoid arthritis treatment Humira, the drugs unit has been driving the company's growth. Humira sales are expected to reach over $200 million in 2003 and between 700-900 million in 2005. It has the potential to become a multi-billion-revenue drug for Abbott if as the company expects it will also be approved as a treatment for psoriatic arthritis, psoriasis and Crohn's disease

The filing for psoriatic arthritis is expected in H1 2005, for psoriasis in H2 2005, for Crohn's disease in H1 2006. These are major milestones, which will potentially drive the company's earnings. In the near term the European Commission approval of Humira expected during Q3 2003 will be a near term driver for Abbott's share price.

The spin-off of the hospital products unit should also lead to a re-evaluation of the stock. Currently it trades at a discount to the pure play pharmaceutical companies (P/E 18.9x vs S&P 500 Pharma Index' 23.1x), due to the slower growth. That discount could start to dissipate, once the company's growth reflects better the growth it achieves in its drug unit.

We reiterate our buy rating for Abbott on the back of this positive development.

Halliburton Co (HAL, $, CSFB: Outperform) is coming closer to its settlement of the Asbestos claims and it looks like the company would not be able to benefit from a change in legislation, which could drastically reduce the settlement cost to Halliburton.

Nevertheless the share price at current levels looks undervalued, even after discounting the value of the settlement. Under current terms Halliburton's full year 2004 would be reduced by $0.09 to $1.29, according to CSFB estimates, which values the stock at a 18x 2004 earnings, a roughly 30% discount to its peers, Schlumberger and Baker Hughes.

Hence we see upside potential in the stock after the settlement closes, and especially since high oil price and positive demand trends for natural gas continue to provide solid fundamentals for the oil sector.

European equities

The DJ EUR Stoxx 50 closed the week 1.7% higher at 2593.55.

• Stora Enso hit our target and we locked in a total return of 24.78% since the beginning of the year.
• We advise to switch into our new recommendations MAN and Siemens.
• Siemens is among the companies most likely to benefit from the upgrade of the US T&D grid

The GDP figures for the 2Q were weaker than expected in most of the European countries. However, sentiment indices point towards an improving 3Q.

As such the release of the ZEW Survey (Economic Sentiment) increased and came in better than expected at 52.5 for August (expected at 46.9, in July 41.9).

The European earnings season so far surprised on the positive side with more companies reporting earnings above expectations. In addition the weakening of the Euro to USD 1.0875 as of last Friday further helped positive sentiments in the equity markets.

Cyclical and technology stocks were among the leaders last week. We would not chase the IT sector at this point, as we believe that the sector looks challenged from a valuation perspective.

We would look at selected cyclical names in order to participate in the current macro driven rally and we would also continue maintain exposure to defensives such as Nestle besides our general theme plays of 'energy' and 'dividend yield'.

We took profit on Stora Enso (STERV FH; EUR 12.14) hitting our target of EUR 12. If the positive macro-led momentum continues the stock could have some further upside potential, however given the steep increase during the last couple of days we believe the share price has run ahead of its fundamentals and have decided to remove the stock from our recommendation list locking in a total return of 24.78% since the beginning of the year. We would suggest switching the funds into our two new recommendations Siemens (SIE GY; EUR 56.64) and MAN (MAN GY; EUR 20.29).

According to a recent research note published by CSPB ('German capital goods sector - on the road to recovery') the IFO Business Climate Index indicates bottom-building in German activity which historically points to positive performance by capital goods stocks and the recent results confirm the success of restructuring measures.

The two main picks to play such a scenario are Siemens and MAN. Looking at valuations, both stocks are trading in line with the European sector average on a price/book and PER measure.

The power outages in North America "shed light" into the run-down state of the US transmission grid most of which was built in the 1930s and 1950s. The Electric Power Research Institute estimates the cost of renovating the transmission grid at around USD 50bn, which is around 25% more investment volume over the coming 10 years.

The earliest renovation contracts are expected to be awarded is in 2004 depending also on the enacting of the pending US energy bill. The company with the biggest exposure is ABB (ABBN VX; CHF 7.86). ABB has over 40% market share in the US Transmission & Distribution Business and derives around 10% of its group revenue from that segment.

Please note ABB remains a high risk recovery story and investors need to take into account the uncertain timing of further disposal proceeds, the restrictive bank covenants and - although diminished - the risk of asbestos liabilities.
Siemens - another possible beneficiary of the upgrade of the US T&D grid - has a market share of more than 10% in the USA but the T&D segment accounts for only around 0.5% of total consolidated revenue.

Among the many companies reporting in Switzerland this week was our defensive pick Nestle. Nestle (NESN VX; CHF 307.50) reported results, which were above expectations and good when compared with the sector and therefore eliminating fears of disappointment in the wake of Unilever's (UNA NA; EUR 52.10) results. 1H 03 results with net income coming in above expectations at CHF 2.78bn which represents however a 51% drop compared to last year, bearing in mind that last year's figure was boosted by a one-time gain.

Sales fell 6.3% to CHF 41.4bn in CHF due to a 12.6% adverse exchange rate impact and organic sales growth which is the new metric chosen by the company to measure sales growth accelerated to 5.5% in the period, which is above analysts' expectations and also higher than the 4.6% reported in the 1Q.

RIG (real internal growth) came in lower than expected at 2.1%. Good news was the improved operating efficiency reflected in the EBITA margin up 30bps to 12.2% (up 70bps to 12.6% in constant currency terms) compared to last year 11.9%.

Guidance of 5-6% organic sales growth was maintained and the management sees 'more favourable trading environment in the 2H'.
Trading on a forward PE of 14x the stock trades around 10% below the sector average, which we believe is not justified especially after these results. Nestle remains our favourite defensive play. Nestle closed the week 6.5% higher.