BusinessWeek Investor: Stocks
C'mon, Take a Walk on the Wild Side Again
The buy sign is out for risky sectors--including tech stocks
With the economy softening and the gloomiest naysayers predicting a recession, you might think investors would be grasping for the safety of defensive stocks--things like health care, food, and utilities that folks have to buy no matter how tough the times. You would be wrong. Instead, market players have been once again betting their money on technology, telecommunications--and even the cyclical retail stocks, reports Birinyi Associates, a Westport (Conn.) firm that tracks money flows in and out of stocks.
Many market strategists say that is exactly what investors should be doing. "Dump your defensive stuff and be aggressive," advises Peter Canelo, U.S. investment strategist at Morgan Stanley Dean Witter. Now that the Federal Reserve is pursuing an easy-money policy, the market offers some attractive buying opportunities. Continued Fed easing "is the best buy signal for stocks that there is," Canelo says, and it should presage a bounceback in the second half. Adds strategist Abby Joseph Cohen of Goldman Sachs: "We think the overall market is undervalued." Her yearend target for the Standard & Poor's 500-stock index is 1650--a 21% gain over recent levels.
In fact, nimble investors who leapt back into technology stocks just ahead of the Fed's first half-point federal funds rate cut on Jan. 3 have pocketed a tidy 28.3%. The retailers are up almost 5%, while telecom has added 12%. But there are good reasons to believe these sectors still have room to run.
Even retailers should see better earnings ahead as lower rates invigorate the economy and boost consumer confidence, leading them to buy again. Also, shoppers should have more to spend as their outlays drop for mortgages and other debt. Besides, these bedraggled stocks may simply be due for a rise. They now trade at a price-to-earnings ratio of 32, down from 36 in December, 1999.NO LONGER BUGGED. Morgan Stanley's Canelo recommends the middle-market chains: Wal-Mart Stores (WMT), Target (TGT), and Kohl's (KSS). Such companies have underperformed since spring, 1999, and are ready to race ahead, he says. At a recent $54, Wal-Mart is 22% off its 52-week high of $65, but Canelo thinks the giant discounter could pop back to $65 in the next 6 to 12 months. Prudential Securities retail analyst Amy Ryan prefers specialty stores like Linens 'N Things (LIN). The company, which sells bedding and housewares, should benefit as lower rates spur home purchases and improvements. Plus, its stores are pushing higher-margin knickknacks such as potpourri and candles, Ryan says.
Investors have already missed out a big move in tech, but that's not a reason to avoid it. The Fed's easing will make it easier for corporations to make the capital expenditures they need for e-business and internal operations. Some tech watchers think demand will pick up as Y2K fades into history. Many companies blew out their tech budgets in advance of the millennium and haven't spent much since.
With their recent runup, tech stocks don't look cheap. Still, tech's p-e ratio, at 37, while higher than the market's, is well below its March, 2000, high of 55. Companies like Oracle (ORCL), the big systems software maker, are primed to move higher. The company reports demand for its enterprise software--programs that link the far-flung operations of a company--should remain strong. The stock is now dragging at $30, down from last year's $46 high, but Credit Suisse First Boston's Wendell Laidley believes that it could climb back to $48.TROUBLESHOOTER. Companies that provide software to the telecom industry are expected to prosper. Analyst Hampton Adams of CIBC World Markets favors Comverse Technology (CMVT), which sells software that lets wireless operators offer voice mail and Internet services to customers. The stock recently closed at $115, off its March, 2000, high of $125. Adams figures it will go to $150 within a year. He also likes Micromuse (MUSE), a company that makes software that data networks use to locate trouble spots. The stock should climb from its recent $87 to $125 within 12 months, Adams says.
In the financial sector, Morgan Stanley's Henry McVey recommends Wall Street firms, which stand to reap fat underwriting fees as corporations take advantage of lower interest rates to sell debt. Lehman Brothers Holdings (LEH), a large bond underwriter, will also benefit from its exposure to the stronger European economy, which is growing faster than the U.S., McVey says. Merrill Lynch (MER) should get a lift from its large fleet of brokers. The firm has been gaining clients who've backed away from online trading during the rocky market environment of the last year. Goldman's Lori Appelbaum adds regional banks such as Firstar (FSR) and FleetBoston Financial (FBF) to the mix, arguing that such institutions will benefit as lower rates spur loan demand and ease default worries. Appelbaum thinks Firstar is a bargain given its recently announced purchase of U.S. Bancorp (USB) and its strong growth potential. FleetBoston, she adds, is undervalued because of perceived bad-loan risks. Appelbaum says the bank has been resolute in dealing with problems early, and she projects the stock to go from its recent $43 to $50 within a year.
Not everyone is pushing an aggressive strategy. Sam Stovall, senior investment strategist at Standard & Poor's, advises investors to play defense. He recommends such defensive sectors as hospitals and nursing homes. They may seem expensive right now, he admits, but they'll look awfully attractive in retrospect if investors in economically sensitive stocks get knocked down in a recession.
Still, with the Fed in an easing mode, history says to be bold. "Almost all the price appreciation of the last 50 years has been during those periods [of Fed easing]," says Ed Keon, Prudential Securities' director of quantitative research. In times of falling rates, says Keon, investors reaped average annualized returns of 20%. That compares with a puny 2% in all other periods. When Alan Greenspan and the Fed governors turn on the engines of economic growth, investors should be ready to go for the ride.By Carol Marie CropperReturn to top