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5 ways to play a modest rebound
Some experts see recovery coming sooner rather than later. If they're right, here are the sectors that may lead the markets in the coming months -- and 13 individual stocks the experts like.
By Michael Brush
One sure way to vaporize wealth over the past 18 months has been to bet on that elusive economic recovery. By now, it may be clear that the best strategy in dealing with stocks is simply to sit things out for the many months -- or years -- it may take for the murky aftermath of the market bubble to play out. Right?
Maybe not, because economists say several recent developments point to a rebound next year. If theyre right, investors need to take positions soon in the kinds of stocks that do well going into a recovery. Well get to that list in a moment. First, heres what has changed on the economic front to support the case for a 2003 rebound.
Whats different now
Economic policy makers have fought the slowdown to date with only one weapon: interest-rate cuts. But they recently opened fire with new artillery. Along with other changes, this should bring the economic turnaround weve all been waiting for, predicts James Paulsen, an economist and chief investment officer at Wells Capital Management, who has correctly called recent turns in the economy and markets.
First, Washington, D.C. is back to its wanton ways of deficit spending. That might bother you philosophically. But its good for the economy. Next, Washington no longer runs a strong dollar policy. This has contributed to the greenbacks weakness, which should boost foreign demand for goods and services made by U.S. companies.
Meanwhile, long-term interest rates have dropped to 40-year lows. This makes money cheaper for those looking to borrow. And inflation looks tame. So theres less risk that fear of interest-rate hikes will squelch stock market rallies on early signs of recovery.
Put all these factors together, and theres good a chance well see a rebound next year. I believe we are in store for an improving economy, although frankly I dont know if it will be particularly robust, says Richard Rosen, a portfolio manager with MacKay Shields MainStay Value fund (MVAAX).
But it doesnt matter, because we dont need a robust rebound to start seeing decent profit growth, say Rosen and some other money managers. Thats because companies have slashed inventories and costs to the bone. So it wont take too much demand to spark some profits, says Ed Jamieson, chief investment officer for Franklin Advisors, a division of Franklin Templeton.
Where will you find those profits if the economy really comes back? First, of course, look for companies where business picks up a lot with a stronger economy, as opposed to those that make staples such as toothpaste or breakfast cereal. Next, aim for areas where capacity is fairly tight, which will lead to decent pricing as demand picks up. Here are some suggestions.
The basic industries
One area where business snaps back with more economic growth is at companies selling the basic building blocks for industrial production, such as paper, chemicals, aluminum and copper.
Most of the commodity producers have been more disciplined in this recession than in the past, particularly if you look at paper companies where there has been flat capacity for the past few years, which is very unusual, Rosen says.
Thats why Rosens MainStay Value fund has staked out positions in paper producers International Paper (IP, news, msgs), Smurfit-Stone Container (SSCC, news, msgs) and Temple-Inland (TIN, news, msgs). Rosen thinks International Paper eventually could move up to around $60, or 10 times peak earnings of $6 per share. Smurfit-Stone, which makes containers, could move to the $22-$25 range on peak earnings of around $2.30 per share. Temple-Inland, meanwhile, might make it to $75 per share in a recovery.
For exposure to metals, Rosen likes Alcoa (AA, news, msgs). True, theres a chance idle capacity will come on line if demand picks up, which wouldnt be good. But theres potential upside because this is a go-to stock for investors when there are signs of an economic rebound, he says. Timothy Ghriskey, of Greenwich, Conn.-based Ghriskey Capital, likes Georgia Gulf (GGC, news, msgs) and Dow Chemical (DOW, news, msgs) as early-cycle plays on a pickup in demand for basic plastics and chemicals.
Transportation stocks
You can expect investors to flock back to railroad stocks if an economic rebound develops, taking them back toward the highs they reached earlier this year. But trends inside the group make these companies attractive on their own merits, says Jeanie Wyatt, a money manager at South Texas Money Management in San Antonio. Her firm has positions in Canadian National Railway (CNI, news, msgs), Union Pacific (UNP, news, msgs) and CSX Corp. (CSX, news, msgs). They are a traditional recovery play but these companies are improving their fundamentals by cutting costs and becoming more efficient operators," she said,
For exposure to trucking, Rosen owns Navistar International (NAV, news, msgs). Hes expecting peak earnings of $6 to $7 per share in a recovery. That suggests the stock could double from current levels of about $26 if it reaches the price-to-earnings multiple of 8 or 9 it normally hits during strong economic times.
Media stocks
When times get hard, one of the easiest budget lines for businesses to cut is advertising. Likewise, ad revenue tends to swell in a recovery. Thats why investors staking out positions ahead of an economic rebound often favor media stocks. An obvious play here is Viacom (VIA, news, msgs) because of its vast media holdings that include CBS television, MTV, Blockbuster and Infinity Broadcasting in radio. Franklin Templetons Jamieson likes Hispanic Broadcasting (HSP, news, msgs) and Univision Communications (UVN, news, msgs). Theyre a play on ad spending, of course. But, he adds, they also benefit from the rapid growth in the Spanish-speaking population in this country.
Media companies like these now trade for around 30% less than their levels reached in the early spring. That was the last time investors loaded up on them --because most forecasters were calling for an early economic rebound. If signs reappear in the next few months that a meaningful recovery is at hand, they could approach those levels again. Two depressed media giants that may not get much of a lift from a rebound because of ongoing troubles, however, are Disney (DIS, news, msgs) and AOL Time-Warner (AOL, news, msgs). Ghriskey thinks Disney may be a good turnaround play. Rosen says hes avoiding AOL Time-Warner above $10 a share because of potential accounting issues and questions about growth on the AOL side of the business.
Technology
As investors turn from value stocks to growth holdings because they see signs of a rebound, theyre bound to rekindle their interest for that mother of all growth sectors: technology. One part of this group theyll probably avoid, though, is telecom equipment makers. Theres still too much capacity.
Semiconductor producers such as Advanced Micro Devices (AMD, news, msgs), Texas Instruments (TXN, news, msgs), Micron Technology (MU, news, msgs) and (Taiwan Semiconductor, TSM)) will be popular. Yes, there are capacity problems here, too. But chips are used in so many products these days that demand picks up nicely with an economic rebound. When the economy bounces back, you will see these stocks do well because people know they are cyclical, says Rosen.
Next, strong chip demand feeds through to companies that make equipment used by chip makers. Major equipment suppliers include: Applied Materials (AMAT, news, msgs), KLA-Tencor (KLAC, news, msgs), Lam Research (LRCX, news, msgs) and Novellus (NVLS, news, msgs).
Not everyone is bullish on the chip sector's prospects, however. We believe the industry will start to make a modest recovery next year, says Steve Szirom, executive editor of InsideChips.com. Because the pickup will be slow, he thinks chip stock investors should be looking for a decent return over several years, not a quick buck.
Hotels
Travel, another discretionary budget item, also tends to increase with a recovery. Thats why Franklin Templetons Jamieson likes the hotel group as a rebound play. They do not have a lot capacity coming on line and what they have is underused because travel is down. So they have a lot of leverage to the upside if demand comes back. We think in a couple of years some hotel stocks could double from here. Two leaders in the group are Host Marriott (HMT, news, msgs) and Starwood Hotels & Resorts (HOT, news, msgs), which runs Sheraton, Westin and W hotels.
What to avoid
Textbooks tell you that consumer-oriented stocks do well early in a recovery. Families typically get hit hard by recessions, so when a rebound comes, they spend a lot to make up for lost time. This time around, though, its different. Consumer spending carried the country through this recession, so there is no pent-up demand, says Mainstay Values Rosen. Instead, the consumer has slowed down recently because of higher debt levels and slower wage growth. If anything, consumer spending could soften.
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