US market liquidity and momentum driven

US Equities

US stocks declined this week as consumer confidence, retail sales and jobless claims cast doubt that growth in the economy and corporate profits would meet expectations.

Retailers such as Home Depot Inc led the drop. A tape allegedly made by Osama bin Laden aired on Al-Jazeera television on the eve of the second anniversary of the September 11 terrorist attacks as well hit the stock market on raising concerns over more terrorist assaults.

On Thursday it would seem that the permabulls once again swept aside important economic data and continue to prop up the market. On a somber day as on the 2nd anniversary of 9/11, we would have believed that it was time to take stock and lock in some of those gains. However, investors appeared to be more concerned about missing out on the "next" up tick and continue to pile in.

Initial Jobless claims rose by 3000 after an upward revision to 419,000 for last week's figure. The recovery remains a jobless one and we believe such a recovery remains precarious and ominously close to an end, though we would be hard pressed to time it given the irrationality of the markets. A fundamentally driven market still eludes us and the rally continues to be liquidity and momentum driven.

A couple of brokers, including CSFB trimmed their estimates on Altria Group (MO US, US$41.02) on the back of lower domestic volumes in the second half of the year and Tax hikes in certain key European countries - namely France and Germany. Lower volumes and the Tax hikes are not news to us and we believe the pull back in MO's price in early August had already reflected this.

We have mentioned before that despite some near term legal concerns, our view is that of a US Tobacco industry with a legal profile in secular decline. We maintain our BUY rating on the stock, which is in line with our thematic play on US Equities with safe and high dividend yields. MO currently yields 6.63%.

Our other dividend plays are Carolina Group (CG US, US$23.04), which currently yields 7.9% and The Macerich Company (MAC US, US$37.84), which yields 6.03%.


Wells Fargo (WFC, $50.27, CSFB: Outperform) share price saw a decline after its competitor National City Corp (NCC, $30.43, CSFB: Underperform) reported that it expects a sizeable reduction in mortgage earnings as early as Q3. National City is largely exposed to mortgage financing, with around 60% of reported earnings derived from mortgage activities.

At Wells Fargo the level 17% of earnings as derived from mortgage activities and the company management recently confirmed that it is comfortable with this level. Hence we believe that for Wells Fargo as for other banks with lower exposure to mortgage activities, a possible drop in mortgage earnings can be overcome by improving market sensitive business contributions, such as commissions and fees.

Wells Fargo's share price recovered from the decline in Friday's trading session. We reiterate our Buy recommendation on Wells Fargo.

The oil service company Halliburton Co (HAL, $24.24, CSFB: Outperform) was in the news over the weekend for the company's work for the US troops stationed in Iraq. Dow Jones Newswire reported, citing an US Army spokesman that Halliburton's US government contracts to restore the oil production in Iraq and support troops is worth about $2 billion.

Halliburton reported in its second quarter earnings announcement that it executed logistics works for the US military in Iraq worth $292 million. How much these revenues from work in Iraq rose over the last month remains a matter of speculation, but the value of the work done by Halliburton is likely to rise.

Also, with its ties to the US administration, HAL is well positioned to benefit from new contracts for maintenance and reconstruction work distributed to companies by the US. However, we also expect non-US companies to play a greater role in the reconstruction of the Iraqi oil industry and infrastructure, as the UN gains more influence.

The share price of Halliburton reached our target price of USD25 last Monday, yielding a 13.83% profit since we recommended the stock on August 1. We are increasing our price target to USD27 in light of the positive news flow and the development in the asbestos case, where we expect the final settlement to be supportive for the Halliburton share price to rally further. We are also setting a sell level at USD 24, in order to protect some of the gains in the stock.

International Business Machines (IBM, $88.70, CSFB: Outperform) rallied on the back of an upgrade by CSFB. The analyst cited the expectation of a recovery of large commercial accounts market, where IBM has a substantial exposure.

He assumes an 8% revenue growth, which is at the upper range of the company's expected long-term average growth rate of 6-8% p.a., and a 13.5% pre-tax return. We expect the stock to rally further, as we believe investors have neglected the stock of late.

The company, as we continuously highlighted has been doing well and has added new IT services contracts as well as growing its market share for computer servers. This positive development in the currently slow IT spending environment makes IBM a top pick in the technology sector.

The medical company Abbott Laboratories (ABT, $44.06, CSFB: Not rated) last week received European Commission approval for its rheumatoid arthritis drug Humira. Abbott expects sales in US and Europe to reach $250 million this year. Humira, which was launched in the US at the beginning of the year is forecasted to achieve $1 billion in annual sales by 2005/2006 and has the potential to become a multibillion-revenue drug for the company if approved.

As we forecasted the European approval of Humira would be a significant milestone. The stock rose 2.3% on the back of this approval and 10.4% since recommendation on August 8.

The stock additionally benefited from some momentum related to an article in Barron's that highlighted the company along with Pfizer, Merck and Johnson & Johnson to be attractive in terms of valuations.

European equities

The DJ EUR Stoxx 50 closed the week 2.6% lower at 2546.78 cancelling out the previous week's gains.

• Sector rotation towards pharma continues.
• CSFB raised European equities from 3 to 8% overweight

CSFB raised European equities from 3% overweight to 8% overweight on the back of valuations, realistic earnings expectations (without energy and financials EPS is expected to decrease by 7% this year), improvement in relative unit labor cost and better policy backdrop once Jean-Claude Trichet becomes the new ECB president in November.

Jean-Claude Trichet made his first speech to the European Parliament last week. Trichet says that sound fiscal policies and boosting confidence is key to economic growth. Budget overspending can hurt confidence and therefore sees the EU's stability and growth pact as a necessity. In addition, the ECB said it expects 2H growth to spill into 2004.

Over the weekend the Swedes decided not to join the European Monetary Union (EMU) with a vote of 56 % against, 42% in favour and 2% blank. With this decision Sweden, which is now the only EU member outside the Euro and Nato, delays any future referenda in Denmark and the United Kingdom.

As markets remained in consolidation mood, sector rotation from auto/tech into pharma continued. The pharma sector looks likely to have made a medium term bottom and we would reiterate Sanofi-Synthelabo (SAN FP; EUR 54.20) and Aventis (AVE FP; EUR 48.20).

Aventis and originator Genta have released positive phase III data on a cancer therapy called Genasense. Genasense is a drug that enhances the action of chemotherapy. CSFB applies a 66% probability that the drug will be approved by 1H 04 which would result in a EUR 0.01 increase in 04 EPS estimates.

During a presentation at the Frankfurt Auto Show, DaimlerChrysler (DCX GY; EUR 33.35) announced 9 new products in 04 at the Chrysler division and several new product launches at Mercedes in 04/05. The management's comment that 04 profits at Mercedes would be largely flat yoy, which would lead to a disappointment. In addition, the breakeven target on the operating level at the Chrysler division in 03 is looking challenging.

However, we believe that this is largely priced in and continue to like the stock on an 18-months horizon. DaimlerChrysler also announced the investment of EUR 1bn in China in a joint venture with Beijing Automotive Industry Corporation to build Mercedes cars and trucks in China, which we see as a positive in the long-term, but believe would put some short-term pressure on the stock.

We would use any short-term weakness as a buying opportunity, as we believe DaimlerChrysler provides an interesting combination between cyclical exposure and dividend yield (indicative dividend yield 4.5%).

This week's focus was on the luxury goods sector as Hermes (RMS FP; EUR 139), Bulgari (BUL IM; EUR 6.505) and LVMH (MC FP; EUR 53.70) reported. Whereas the results confirmed the improvement in trend in June to August, a further outperformance of the sector depends on the shift back to cyclicals.

We would reiterate The Swatch Group (UHR VX; CHF 134.50) as our preferred play of the sector combining attractive valuations, improving business mix and on going cost cutting initiatives.

Nokia's (NOK1V FH; EUR 13.72) midquarter update was not well received by the market. Nokia confirmed its previous forecast of mobile phone 3Q revenue to be 'flat or slightly down' compared to a year ago due to a drop in average selling price. Network sales will also be in line with guidance (down 15-20% yoy).

The market seemed to have expected a rebound in phone sales and seemed to be disappointed with the operating profit in the network unit, which has not yet managed to break-even. On the positive side was the announcement that EPS will likely be 'at the high end or slightly above' its previous forecast of EUR 0.15-0.17. After the recent outperformance of the sector we remain cautious, as we believe growth rates and profitability will be limited due to competitive pressure.

Our new trading buy SAP AG (SAP GY; EUR 113.03) suffered alongside the technology sector during the last couple of days and came under renewed pressure on Friday after Oracle released weaker than expected license revenue (6% yoy decline and 10% decline qoq). EPS was in line with expectations at USD 0.08. The area in which Oracle competes with SAP - applications business - came in weak in the US and the Asia Pacific while Europe was unusually strong.

The stock closed the week just above our stop-loss level. As we recommended SAP as a trading call we will be strict with our stop loss level and will be watching the stock closely for a possible removal from our list to protect the downside.

Fundamentally, we continue to like the stock for an investor with a long-term horizon. Whereas the difference in growth forecast and valuations between the hardware and the software sector is negligible, the higher margin and lower volatility favours the software sector.

SAP's valuation is in line with the sector and whereas the 3Q could remain difficult, the fourth and most important quarter for the company could provide an opportunity for earnings revision.