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Tech and growth are hot -- again
That is, if you believe in the rally. Despite a few bumps, there are reasons to think that it's real and sustainable. Some fund investors have already shifted their assets.
By Timothy Middleton
War has shaken Wall Street like a disobedient child, and the result has been a reversal of the trends put in play by the bear market -- along with a warning that a prolonged engagement could turn the rally into a rout.
In the first flush of bombing in Iraq, the markets response was immediate and dramatic.
There was "a very rapid rotation by investors into the economically sensitive sectors of the market that typically do well coming out of bear markets, says Sam Stovall, chief market strategist for Standard & Poors Corp.
The chief mutual fund beneficiary -- at least last week -- has been technology portfolios, with many posting double-digit gains in the week ended March 19. More generally, small and value stocks, which have done the best for the last three years, sputtered out in the war rally, replaced by large-cap growth funds.
Youre starting to see people coming back to areas that are leveraged to the economy, says Brian Belski, market strategist for U.S. Bancorp Piper Jaffray. The sector trends are starting to show signs that the market is positioning for a recovery.
Whether the bear market actually expired on March 11, the market began to behave as if it had. The rally that began the following day was prompted by the fall in the yield of the 10-year Treasury note to its lowest level in decades, vividly demonstrating how few alternatives investors have to common stocks.
The right characteristics
Says Craig Callahan, chief investment officer for Icon Funds, I just dont know if this is the beginning of a sustainable rally, but it has all the characteristics we were looking for.
If it's sustained (and Mondays market requires examining the question), your bear-market funds belong in the dustbin, replaced by those 1990s stars, technology and growth.
The market was consistently in negative territory throughout the first quarter, until President Bush threw down the gauntlet and made clear that the United States would invade Iraq. It was a move that horrified Europe and much of the Left Coast, but was cheered from Wall Street to Topeka.
The market seems to have reacted not unlike it did when Desert Shield became Desert Storm 12 years ago, says Jim Griffin, portfolio manager with ING Aeltus Investment Management. Bushs stand resolved the issue of if into a matter of when, which eliminated the uncertainty that had weighed investors down.
The reversal was broad as well as sharp. Before March 11, the S&P 500 Index ($INX) was down 9% so far this year, and 91 of the 105 industries the firm tracks were in negative territory. In the week after March 12, the S&P 500 spurted 8%, and all but two industries turned positive.
The exceptions were tobacco, burdened by the threat of yet another federal lawsuit, and oil and gas exploration, spanked by falling oil prices.
Broad as the rally was, however, it was selective, favoring bigness and growth over smallness and value.
By the numbers
Morningstars large-cap index rose 0.62% in the week ended March 14, while the small-cap measure declined 0.15%. The U.S. Value Index was down 1.03%, while U.S. Growth spurted 1.55%. Large Growth accelerated even more, 1.80%.
Four of the five stocks in Morningstars Large Growth index surged 5.5% or more, paced by an 8% gain at Oracle (ORCL, news, msgs). Contrariwise, four of the five stocks in Morningstars Small Value index fell 6% or more, including a 45.9% crash in AMR Corp. (AMR, news, msgs), the parent of troubled American Airlines.
Defensive groups like real estate were the big losers. Morningstar says it declined 4.17% in the week, while medical goods and services fell 7.54%.
Griffin says the markets tone has reversed because, when it failed to go lower than it had last October, that signaled a more constructive mentality. Having seen the lows -- thats very important -- the money I put in the market today isnt immediately going to suffer a haircut. Now its a matter of patience and working our way through the global imbalances.
Managers of technology funds, after three years in the doghouse, emerged toward the end of the first quarter in the penthouse, luxuriating in double-digit gains. S&Ps technology index spurted 12.5% in the week following the March 11 low.
One of the biggest recent winners was one of the biggest losers of the last few years -- Amerindo Technology D (ATCHX). Having shed an average of 49.9% of its value in each of the three years ended March 19, in the final week of that period it surged 15.2%, bringing its year-to-date returns to a gain of 22.2%.
Turning the tide
Another shell-shocked survivor was Jim Oelschlager, manager of the Oak family of funds. Black Oak Emerging Technology (BOGSX), down 57.4% in the last year, spurted 11% in the last week. White Oak Growth (WOGSX), down 35.3% over 12 months, advanced 12.2% in seven days.
I think its a reaction to the fact (technology has) been beaten up so hard, Oelschlager says. When you look out a couple of years, you can see that technology is where the growth is. Technology and semiconductors are going to be the oil of the next industrial revolution.
Fifth Third Technology Fund (FTTCX), which had the misfortune of launching three months after the Internet bubble burst in 2000, advanced 8.4% in the week after the market bottom.
Part of the rally was due to short covering, manager Sunil Reddy says, but part was because people became rational again. High-tech companies for the most part are meeting expectations. He also says the group has slashed costs ruthlessly, so when business revives, margins will be higher and the growth in profits explosive.
Those who believe a new bull market has been born cite as one proof that investor sentiment remains in the dumps. Just as bear markets arrive when optimism is highest, bulls arrive when pessimism reigns. And it does.
It may take some time
Im not sanguine about the recovery of the market, says Bernie Horn, manager of Polaris Global Value Fund (PGVFX), which resisted the bear market for the last three years, but is down 4.9% this year, as of March 19. He has reduced his exposure to U.S. stocks to 45% from 55% in recent months.
Quite a lot of overcapacity has to be grown into before corporate profits can revive, Horn says.
And economic data suggest that wont happen quickly. Industrial production has been growing at an anemic 0.1% rate. Inflation has reared its head, with wholesale prices climbing 1% in February. The University of Michigan's Consumer Sentiment Index hit a 10-year low in March.
Unemployment has become intractable, especially in the knowledge economy. Corporate earnings remain extremely weak, with far more companies talking expectations down than up. That will continue to weigh on stocks well into the second half of the year.
Says Piper Jaffrays Belski: We dont think this is the start of the bull market. We think this is just a big bounce.
But gloom is a tonic to contrarians, which I am. (And which led me to wrongly believe, twice before in the bear market, that the worst was done.) So is Callahan of Icon, who relishes the fact that equity mutual funds have experienced record outflows in the last year.
Investors have a history of making major asset-class switches at the wrong time, says Callahan, who has a Ph.D. in finance. They get out of stocks at the bottom. The big move by investors the last few months into cash, bonds and gold, and out of equities, is a classic pre-bottom move.
Forming a bottom doesnt mean stocks are headed straight up. They pulled back Monday at the first sign of a prolonged Iraqi war, and they increasingly are characterized by extreme volatility that belies investors nervousness. But finding a bottom will help ease the jitters.
From a technical point of view, the successful test on March 11 of last October's market low raises to well above 50% the likelihood the bear has been slain. But war rattles my confidence in that indicator, because a serious reversal for the United States on the battlefield would send stocks plunging, technicals or no technicals.
But I can say with confidence the market is at least near a low, and that within three years it will be well above where it is now. If you can't invest for at least three years, try a bank instead.
What they're buying now
Looking abroad: If you are with Horn, shun U.S. stocks for foreign ones such as Italys Parmalat Finanziaria (IT:PRF, news, msgs), a holding company whose prize is the maker of ultra pasteurized milk and other boxed fresh foods. The shares are down 60% in the last year because theyve misstepped on their financial structure, Horn says, but theyve clearly got enough cash flow to pay down all the debt theyve accumulated through acquisitions.
Focus on the consumer: If you are with Amerindo, stock up on high-tech companies that sell directly to consumers, rather than other businesses. We like Amazon.com (AMZN, news, msgs), says Michael Sandifer, a member of the funds investment committee. We like companies where you and I use the product. Weve still been able to function, while the business person has gone into a catatonic stupor. Other favorites include eBay (EBAY, news, msgs) and Yahoo! (YHOO, news, msgs).
At the time of publication, Timothy Middleton didnt own any securities mentioned in this article.
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