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Your best market bets for profit in 2003
Expect solid economic growth in the 4% range and another bumpy year of market swings in 2003, the pros say. Look for sector strength in basic industries and energy -- and, perhaps, a pickup in tech spending.
By Michael Brush
Crushed by stocks and rewarded by bonds for three years running, many investors will go with the flow and position themselves for more of the same as they look ahead to 2003.
Thats likely to be a mistake.
Thanks to several economic and political forces -- plus a bullish signal from corporate insiders buying their own shares -- it makes the most sense to expect decent economic growth next year that will favor cyclical stocks and hurt bonds.
Expect lots of hand-wringing along the way. But when all the books are closed on 2003, the economy should post growth in the 4% range. Even economists and value managers not known for their optimism during this bear market point to such an outcome. And if theyre right, that economic expansion should be enough to favor shares in economically-sensitive areas like energy, industrials, basic materials and technology -- though dont expect a party like its 1999.
Iraq, China, terrorism on the horizon
To be sure, its impossible for anyone to be certain how the future will unfold. And next year, there are plenty of problems that could rise up to derail a strong growth scenario. China, for example, will continue to steal manufacturing jobs, hurting companies and capping employment growth in this sector in the United States. Meantime, U.S. consumers already own more than enough big-ticket items like cars and appliances -- the kinds of purchases funded with the help of low interest rates and a home refinancing boom thats winding down.
No one knows what will happen with Iraq or terrorism, or how much bad news on these fronts will hit stocks. And what if the Democrats manage to foil Republican efforts in Washington to juice the economy ahead of the next presidential election?
Indeed, because of these risks -- and uncertainty about the stutter-step recovery -- you can expect last years record market volatility to continue. In short, its likely to be another traders market, but with a bias to the upside and cyclical stocks. Heres a closer look at some of the major investing trends.
The economy grows
With one party in power in Washington, its going to be a lot easier to pass tax cuts and spending hikes. These are the missing pieces in an economic stimulus package that so far has mainly included lowering interest rates and pushing down the value of the dollar (which boosts domestic manufacturing).
More importantly, we are moving toward a presidential campaign. You can bet the party in power will be doing all it can to stoke the economy to win votes.
During the past century, similar antics have contributed to stocks gains of 12% on average in the third year of the presidential cycle. Republicans seem to play this game better than Democrats. On average when Republicans held the White House, the S&P 500 ($INX) has advanced 22% the year after a mid-term election.
Given how much companies have cut costs during the slump, any improvement should drop right to the bottom line.
I think the economy is going to do a lot better, and if the economy improves, you get two kickers to the market, says James Paulsen, an economist and chief market strategist at Wells Capital Management. One, from profits going up, and another from people valuing those profits higher because the pessimism ends.
Ken Fisher of Fisher Investments goes one step further, projecting that moves by central banks around the world to lower rates and increase money supplies will bring back a bull market. I am wildly bullish for next year, he proclaims. For the first time, we are creating excess global liquidity, and the excess liquidity will eventually work its way around to stocks. I predict the market will be up 35% next year.
Whats striking about the bullish views you hear these days from Paulsen and most of the money managers contributing to this column is that they come from natural contrarians who have been skeptical about the hopes for stock market rebounds throughout much of the bear market.
Bears are baited
Bears, of course, will have a field day with all this. But some of the bear arguments are getting a little frayed around the edges. Many bears, for example, still cling to the idea that bear markets following a bubble simply have to last longer than what weve been through.
A look back shows we may already have done enough time. If you make a composite chart of four recent bubbles -- in gold and oil in 1980, the Nikkei in 1989 and the S&P 500 in 1929 -- and overlay it onto a recent Nasdaq ($COMPX) chart, two striking points emerge, according to Bear Stearns. First, the bear markets that follow bubbles typically bottom and begin to turn up about 2.3 years after the bubble peak. That would be right about now. Next, bubbles tend to pull back by 60% on average. The Nasdaq fell by 77% at its recent lows.
Traders market remains in force
Still, theres enough fear and doubt out there -- and bears and short-sellers to feed it -- that you can expect this years wild volatility to continue. (On 44 of the 211 trading days through Oct. 31, the S&P 500 rose or fell by at least 2%.) That means two things: If you are a sharp trader, there will be plenty more opportunity. And if you are staking out long positions, you can afford to be patient and wait for good prices.
Economic growth will come in fits and starts, and that will cause a lot of volatility and anxiety, so you have to be very disciplined, says Robert Rodriguez, a value manager at First Pacific Advisors. Right now, for example, hes holding off on buying much, because of the sharp run since the Oct. 10 lows.
A brief war with Iraq will probably have the following effect, if history is a guide, says Prudential analyst Ed Keon: The stock market will stay weak and cautious leading up to a conflict, but then move up sharply once uncertainty is gone and victory looks clear.
The dam may break in tech spending
If theres one area where spending seems overdue, its technology. The last major tech binge occurred in the late 1990s, and a lot of the PCs, servers, networking gear and software bought back then are aging ungracefully and starting to eat into productivity.
In short, companies risk losing their competitive edge unless they upgrade, and that should start happening next year, says Rodriguez. I have gotten a lot of debate on that because things are so negative in the tech arena, but we think it will start to gain traction next year.
Roger McNamee, a partner at tech investment company Integral Capital Partners, says some recent polls of corporate finance chiefs show confidence is picking up. That is a huge deal for tech spending, he says. We will see a gradual increase in technology budgets over the next 20 months. McNamee thinks the best plays are tech suppliers who arent too diversified, and whose goods have distinct product cycles. One example: Web software company BEA Systems (BEAS, news, msgs).
Many of the riskier tech stocks in areas like telecom equipment, of course, have already snapped back nicely since early October. Thats why value manager John Buckingham of the Al Frank Fund (VALUX) favors the safer tech stocks. In this case, the safe techs are the ones with strong financials that havent advanced 200%; in fact, unlike more risky issues, they never got crushed in the first place.
One example is Apple Computer (AAPL, news, msgs), which has $12 per share in cash and no debt. It trades at around $14 per share, which means you can buy the business for $2 per share. Others include 3Com (COMS, news, msgs), Compuware (CPWR, news, msgs) and Kemet (KEM, news, msgs). He also likes semiconductor stocks that havent moved as much as the group itself -- stocks like Credence Systems (CMOS, news, msgs) or Integrated Silicon Solution (ISSI, news, msgs). These companies wont appreciate 100%, but they will certainly enjoy their day in the sun, Buckingham says.
Some words of caution on tech. Given the bounce since early October lows, a bigger correction could be in store (even beyond the December pullback). And remember, the late 1990s arent coming back next year. We can hope they never will.
Industrials, basic materials and energy gain favor
Companies making the basic building blocks for industry -- products like steel, chemicals, aluminum, paper and fuel -- tend to do better as an economy recovers. Many are getting another boost right now as the dollar weakens, shifting orders back to U.S.-based companies. A third positive is the impressive level of cost cuts theyve made during the downturn. Examples of basic materials companies include Dow Chemical (DOW, news, msgs), Alcoa (AA, news, msgs), PPG Industries (PPG, news, msgs), Air Products & Chemicals (APD, news, msgs), Phelps Dodge (PD, news, msgs) and International Paper (IP, news, msgs).
Energy stocks do well in a recovery, too, but they are also benefiting from looming shortages -- particularly in the North American natural gas market. But theres a medium-term shortage building in world oil supplies, too.
Stock plays in North American natural gas (the sector has risen recently on colder than expected weather) include Patterson-UTI Energy (PTEN, news, msgs) and Ensco International (ESV, news, msgs).
Tide moves against bonds
As an economy recovers, bond prices fall as investors fret about inflation or future Fed rate hikes -- and sell bonds or demand lower prices to build in higher returns. Thats likely to happen in 2003. And if the economy does improve, bond prices will sink as investors flee them to buy stocks. You can also expect a glut of debt on the market to fund bigger government deficits, which will also weigh on bond prices. In short, bonds are bad for next year.
But there are exceptions for income-oriented investors. First, if you are simply holding bonds to maturity -- and not trading -- none of this matters. And Treasury Inflation-Protected Securities, or TIPS, adjust interest payouts to protect you against this problem.
Third, the prices of bonds issued by companies with weaker financials should buck the trend and move up as the economy strengthens and investors gain confidence these companies arent headed for bankruptcy, says Mary Miller, a bond portfolio manager at T. Rowe Price. Examples include the debt of Qwest Communications (Q, news, msgs), Collins & Aikman (CKC, news, msgs) and Sanmina-SCI (SANM, news, msgs), say bond analysts at First Pacific Advisors.
Key consumer stocks take a hit
Consumers, of course, have kept on spending as lower interest rates have filled their coffers with proceeds from loans and better terms on home mortgages. If the economy recovers, interest rates will either move up or stop falling, shutting down the mortgage refinance spigot. These changes could hurt consumer-oriented companies -- especially those making big-ticket items bought on loans, like cars and refrigerators. Next, in a recovery, investors will flee more defensive companies, like those providing consumer staples and health-care services.
Third, be wary of deflation. While it wont be a risk to the overall economy, certain sectors will suffer as foreign competitors continue to produce cheaper goods. U.S.-based furniture manufacturers like Furniture Brands (FBN, news, msgs), La-Z-Boy (LZB, news, msgs) and Stanley Furniture (STLY, news, msgs) face risks. On the other hand, Cognizant Technology Solutions (CTSH, news, msgs), which uses lower-paid code writers in India to solve software problems for U.S. companies, has found a way to make international wage differentials work in its favor.
And if youve been holding high-dividend stocks to get some protection against the stock market declines, double-check the growth outlook for those businesses. Though they may benefit from more favorable tax treatment of dividends this year, companies paying strong dividends often operate in mature, slower-growing areas of the economy, and theyll be left behind if growth picks up next year.
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