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"There Are Few Steals in Technology"

As a practitioner of the value strategy of investing, David G. Sowerby, portfolio manager for Loomis Sayles & Co., has seen his stocks climb 20% since the Nasdaq peaked more than a year ago -- a period in which most names have been down or, at best, flat.

He's optimistic about the stock market now, even though investors still have to wait for corporate earnings to improve. A number of sectors, including techology, energy, and financials present value now, he believes. Sowerby made these and many other comments in a chat presented June 14 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff and Amey Stone. Edited excerpts from the chat follow -- for a full transcript on AOL, go to keyword: BW Talk.

Q: The market has been having good days and bad days. What's your current macro outlook?

A: I believe that there are more positive forces behind the market than negative ones confronting it. Importantly, the current quarter is still quite positive -- it should finish up 7% to 8%. More importantly, I think that positive direction should prevail for the remainder of this year. The positive fundamentals include low inflation, low interest rates, and the recent tax cut.

Q: How have the stocks you manage been holding up?

A: Since the peak in the Nasdaq, our value portfolios are up more than 20% In an otherwise flat to down stock market.... The last five quarters have reinforced the long-term notion that valuation still matters when you purchase a stock.

Q: Is now the right time to sell my JDS Uniphase (JDSU)?

A: Unfortunately, the right time to have sold most of the fiberoptic/telecom-equipment stocks was almost a year ago. Today, I wouldn't be a buyer of JDS Uniphase. Rather, I would be looking selectively in more stable areas of technology where earnings are more credible and more reliable.... There are better opportunities in the semiconductor stocks, the hardware stocks, and the enterprise software stocks if you want to find a home in technology.

Q: Thoughts on EMC?

A: I would look at EMC (EMC) as a near-term opportunistic buy, as well as a long-term hold for almost any portfolio that wants representation within technology. This is certainly not a bullet-proof stock. But encouragingly, when companies begin to reinvigorate their IT spending, it will be for storage space.

Q: Can you give us some names in those niches in tech you find more attractive?

A: Sticking to my expectations that you want to be buying relatively attractive valuations with realistic earnings, here are six technology names that are worth owning in your portfolios. In addition to EMC, the recent weakness in Nokia (NOK) presents a more attractive entry point. Also, more stable technology plays, such as Concord EFS (CEFT), First Data (FDC), IBM (IBM), and ADC Telecommunications (ADCT).

Q: What do you think of Veritas (VRTS)?

A: Among software stocks, I would rather be an owner of Microsoft (MSFT), Computer Associates (CA), and perhaps BMC Software (BMC). Nevertheless, among stocks within its industry group, Veritas has an above-average earnings growth of 25% to 30% over the next three years. The one caution would be the valuation, which at 73 times 2001 earnings still looks expensive for many investors.

Q: What companies do you like in the energy sector for the long term?

A: I think there are positive opportunities both in the integrated, larger oil stocks such as Exxon Mobil (XOM), Chevron (CHV), and British Petroleum (BP), and in the oil-service and drilling stocks. While volatility will be higher there, there are opportunities in Anadarko (APC), Baker Hughes (BHI), Ensco (ESV), Santa Fe International (SDC), Schlumberger (SLB), and Transocean Sedco Forex (RIG).

Q: What is your opinion of the IPO market and Kraft?

A: As a father of three and a major customer of Kraft Macaroni and Cheese and Chips Ahoy, we believe that Kraft is likely the best food stock to own for long-term investors. Although the IPO at approximately $31 a share is relatively close to our one-year price target of $34 per share, over the longer term Kraft represents significant value in the pure food plays. Besides Kraft, other possibilities would include PepsiCo (PEP) and Budweiser (Anheuser-Busch) (BUD).

Q: Do you have any current favorites in the financial sector?

A: ...[It] represents the largest weighting in our portfolios, at over 20%. I think there are very good opportunities in the banking, insurance, and brokerage sectors. Names to focus on would include U.S. Bancorp (USB), Wells Fargo (WFC), Citigroup (C), and Washington Mutual (WM), classified as banks or thrifts. In the insurance sector, John Hancock (JHF) and ACE Limited (ACE) are attractive names. I would also include Allstate (ALL) in this category. Finally, in the brokerage industry, I am somewhat more tempered. But...I see opportunities in Morgan Stanley (MWD), Merrill Lynch (MER), and Goldman Sachs (GS). The last three stocks will benefit from any modest improvement in technology stocks, as well as the general business environment.

Q: You've probably already mentioned some of the value stocks that have done well for you in the last year or so, but I'm curious what some of your other winners have been.

A: ...our gains have come across all sectors, with the most sizable winners being financials, such as ACE, PNC Financial (PNC), and Wells Fargo. Energy stocks have benefited, which would include Transocean and Texaco (TX). Health-care stocks were favorable winners in the second half of 2000, including Merck (MRK), Bristol-Myers (BMY), Baxter (BAX), and Tenet Healthcare (THC). More recently, health-care stocks have been weaker, but I see opportunity for Merck, Pfizer (PFE), and Johnson & Johnson (JNJ). Finally, in technology, we have needed bandages, instead of stitches, thanks to positive gains in First Data, IBM, and Concord.

Q: Do you think Oracle (ORCL) is a steal right now?

A: No. There are few steals in technology. In the case of Oracle, there are probably more compelling alternatives. Without hedging, I would simply say that Oracle is more of a hold than an outright buy. And the tech stocks I mentioned previously, as well as other viable enterprise software stocks, such as Rational Software (RATL), SunGard Data Systems (SDS), and VeriSign (VRSN), look more attractive, given today's prices.

Q: Is it possible to see a total market meltdown?

A: ...If you still own those once-infallible Internet stocks, there could be additional pints of blood to be donated. But a total meltdown in the market? I strongly don't believe so. When I combine the positive factors of improving market breadth, the fact that the average stock in a broad universe such as the Russell 3000 has a p-e ratio of approximately 12 on 2001 earnings, and my longer-term optimism on low inflation, the Federal Reserve rate cuts this year, and the tax cut, this all suggests to me there is a 12% upside still this year.

Q: Earlier you said you saw earnings improving this quarter. Is that from

year-ago levels? Or from last quarter? I thought most analysts thought earnings were going to be pretty bad for a while yet.

A: You're right. I think the market will improve. But the prospects for corporate earnings are that they will get uglier before they ultimately get better. The trough will come in the third quarter, down 15% year-over-year. For the entire calendar year of 2001, earnings could be down as much as 10%. And a noticeable rebound won't come until the first quarter of next year.

Q: Can you summarize for us where you recommend investors put new money now?

A: If I had money on the sidelines, I would view the very recent setback in the stock market as an entry point....I would be candidly prepared for more sell-offs, but ultimately believe that money put to work today will be noticeably higher by yearend.

I'm realistic enough to know that I will never catch the bottom and am perfectly willing to buy stocks tomorrow and watch my value drop 5% before it witnesses a 25% gain. If I can honestly accept that, I would go shopping tomorrow. That's the case even in the face of negative corporate profit news, because ultimately the liquidity provided by the Federal Reserve Board will win that tug-of-war battle with weak profits.

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