5 safe sectors in a stormy market
[this article was borrowed from another thread]
In times like these, it can be wise to follow the contrarians. Here are some key stock groups you may want to consider as Wall Street awaits better times.
By Michael Brush
Posted 7/17/2002
Daily accounting scandals, terror threats and a sputtering recovery -- who would invest in U.S. stocks right now?
Hardly anyone, except a few bold contrarian investors, or those people who think the best time to buy is when things appear the bleakest. Intriguingly, several in this camp today are the same skeptical money managers who tried to poke holes in the notion of a market bubble the last time stock investors were at an emotional extreme, in 1999-2000. And you’d be surprised what they are buying: tech, of all things.
But given that any firm economic recovery may now be postponed to 2003, it may make more sense to tilt to more defensive areas such as hospitals and precious metals (if you stay in the market at all), say several money managers. Many of them think cash isn’t a bad place to be either.
True, stocks have gotten hammered to the point where they now look attractive by some valuation measures. Edward Yardeni, a market strategist with Prudential Securities, notes that one favorite Federal Reserve Board valuation measure shows stocks haven’t been this cheap since 1979. The Fed yardstick compares the earnings yield for the S&P 500 (the inverse of its price-to-earnings ratio) to the yield of 10-year Treasury notes. Right now the difference is around 6.2% vs. 4.6%. The last time the gap got so large, in December 1979, stocks went on to outperform nicely for two decades.
All this would make Yardeni more bullish on stocks, except for a little monkey wrench the Securities and Exchange Commission has thrown into the mix. It has ordered the chief executives at nearly 1,000 companies to personally sign off on the books in the quarterly reports they file after Aug. 14. Since most of those reports will come in September, that could effectively put a cap on stock prices until then, as investors wait to see what kind of bad news the show-and-tell order dredges up.
Where the contrarians are
If, like the contrarians, you think stocks have already been beaten up enough, here are five sectors that should provide some upside and relative safety -- with a smattering of contrarian tech plays mixed in.
Foreign stocks as a play on the declining U.S. dollar. Foreigners are spooked by all the U.S. accounting scandals, too, and they’ve been pulling money out of the markets here. That has put pressure on the dollar. The greenback should continue to weaken because economic activity and interest rates in Europe are likely to increase more than in the U.S., says Oscar Castro, a foreign stock analyst at Montgomery Asset Management.
So it makes sense to invest in foreign companies for a simple reason. “Their currencies are appreciating, which means even if the stock price stays flat you still make money,” says Jason Selch, an analyst with Liberty Wanger Asset Management’s Acorn Fund, which has increased its foreign stock holdings significantly this year. Foreign stocks may also do better as money flows from the United States into other markets.
A good way to get exposure to foreign markets is through mutual funds such as the Liberty Acorn International Fund (ACINX) or the Montgomery Funds II International Growth Portfolio (MIIGX).
Since the currencies in emerging market countries tend to move in line with the dollar, there’s no play in a declining dollar there, says Frank Chiang, of Montgomery Emerging Market Fund (MNEMX). But a weaker dollar usually makes commodity prices rise, which would help Brazil’s Aracruz Celulose (ARA, news, msgs), a paper company, and Lukoil (LUKOY, news, msgs), a Russian oil company, two holdings in that fund.
Hospitals and medical technology companies. People will always get sick, and the population is aging. So medical-related stocks make sense as defensive plays, says Linda Miller, who manages the John Hancock Health Sciences A fund (JHGRX). But there are also several positive trends in the group, she notes. Many hospitals have been restructuring and building bigger positions in their markets. So their costs are down, and insurers can’t bully them as much on pricing. The government has been friendlier, too, on reimbursements.
Four hospital companies with strong earnings estimate revisions are: HCA-The Healthcare Co. (HCA, news, msgs), Tenet Healthcare (THC, news, msgs), LifePoint Hospitals (LPNT, news, msgs) and Community Health Systems (CYH, news, msgs).
In medical devices, two companies look strong because they have some of the best technology in their niches, says Christopher Orndorff of Payden & Rygel, a money management firm. They also have decent upward earnings estimate revisions.
Hologic (HOLX, news, msgs) produces equipment used in digital mammography. Analysts expect it to win approval for a more advanced line of equipment later this year. Although Hologic goes up against tough competition in General Electric (GE, news, msgs), it has superior technology. It also has a strong ally, Siemens (SI, news, msgs), which may eventually buy Hologic, says Orndorff. Merit Medical Systems (MMSI, news, msgs) makes products used in cardiovascular surgery like catheters and syringes. Paydenfunds Small Cap Leaders (PSCLX) holds shares in both companies.
Precious metals. Gold and precious-metal mining stocks have backed off from highs set around the end of May. But the factors that sparked their tremendous run-up in the first five months of the year are still in place -- and should put them back on an upward course, analysts say.
Factors favoring precious metals include: inflation, continued weakness in stocks overall and the fear of more terrorist strikes. Investors are also buying gold and silver as part of an arbitrage play that makes sense because borrowing costs are much lower than expected inflation. This means investors can borrow money, park it in gold, and pay it back later in cheaper currency that was devalued by inflation.
Mining companies that haven’t hedged away all the benefits from rising precious metal prices include Harmony Gold (HGMCY, news, msgs), Gold Fields (GFI, news, msgs) and Apex Silver Mines (SIL, news, msgs). Despite high commissions, investors also buy the metals themselves, as a cleaner play on the price moves of gold and silver. This way, you aren’t betting on a mining company management, says Leonard Kaplan, president of Prospector Asset Management.
Early cyclical stocks as a play on economic recovery in 2003. Many economists have already written off the prospects for strong economic recovery this year. But thanks to a weakening dollar, increased government spending and declining long-term interest rates, the chances are better that we might see some relief next year.
That’s why Tom Mahowald, the director of equity research at American Express Financial Advisors, likes industrial companies that would benefit once business increases capital spending again -- especially U.S.-based companies with a big overseas presence that helps them benefit from the falling dollar.
Examples include Minnesota Mining and Manufacturing (MMM, news, msgs), General Electric (GE, news, msgs), Emerson Electric (EMR, news, msgs), Illinois Tool Works (ITW, news, msgs) and W. W. Grainger (GWW, news, msgs). “I don’t know the timing, but I know the companies that will do well when the economy recovers,” says Mahowald. “The common themes here are that they are well managed, and they are leveraged to pick up in business spending.” These companies are also relatively cheaper than early cyclical stocks in areas like plastics and chemicals, which have already moved up in anticipation of a rebound.
Tech as a contrarian play. Early in the bubble days, analysts at Rocker Partners were among the most vocal in criticizing a market gone mad. Now they are picking up some of the former tech high fliers at prices they think are cheap. Could they be too early, as with their skepticism of the market bubble? You bet.
But when the dust settles and business spending comes back, they expect decent gains from Powerwave Technologies (PWAV, news, msgs), which makes power amps used in telecom; Interwoven (IWOV, news, msgs), a software company, and Cree (CREE, news, msgs), in the semiconductor space, among others. "We are skeptical sorts, but we have been buying some of this stuff," says Marc Cohodes, of Rocker Partners. All three have clean balance sheets, a decent amount of cash and good management, says Cohodes.
Ben Nahum, a small-cap value manager at the New York-based David J Greene, has been buying shares in software companies Tibco Software (TIBX, news, msgs), E.piphany (EPNY, news, msgs) and Ascential Software (ASCL, news, msgs), as well as Keynote Systems (KEYN, news, msgs), a company that tests Web performance. "I think investing in companies like these can pay enormous dividends over the next 12 months," says Nahum.
Faraz Farzam, of the FMI Focus Fund (FMIOX), agrees some of the most compelling values are among software companies. "Historically, they trade at two times sales when they are broken," he says. Now, many are trading below that. "These stocks are trading at levels where you don’t need to get much spending for things to work." His fund has recently added J.D. Edwards (JDEC, news, msgs) and JDA Software Group (JDAS, news, msgs).
Mark Petrie, a portfolio manager of Hokanson Capital in Solana Beach, Calif., warns anyone fishing in these waters that many tech companies might be trading down so much because the market thinks they are going to disappear. "Only about 10% of the tech companies from the early 1990s still exist. Many tech companies can simply go away because of changes in trends."
And despite the recent market damage, stocks across the board still look overvalued because fundamentals have fallen even more than stock prices, says value manager Robert Rodriguez of First Pacific Advisors, which has beaten the indices so far this year. That makes cash a good option because stocks are going even lower later in the year, before they rebound on better economic news in 2003, he thinks.
"This is the grittiest speculative blow-off in the history of man," says Rodriguez. "Before this stock market malaise is over, you will have to have many, many months of liquidations by investors from mutual funds. It is going to take time. You have to be very patient."
As of the date of publication, Michael Brush owned or controlled no shares mentioned in this article. |
