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"We'll See a Surge in the Market"

Better conditions for the stock market are ahead, perhaps in the next four months, says Pat O'Neil, president of Loring Investment Co. and manager of the Loring Hedge Fund. Meanwhile, O'Neil is buying only Nasdaq and Internet index funds, and he's looking to tech stocks as the best hope for the future.

The hedge fund O'Neil manages is unique in that it only buys stocks long. Many such funds take short positions and also invest in options and commodities. Among the stocks he likes best for future gains now are Intel, Cisco, and, in the consumer field, Best Buy.

O'Neil offered his analysis in a chat presented Aug. 16 by BusinessWeek Online on America Online. He was responding to questions from the audience and from Jack Dierdorff and Karyn McCormack of BW Online. Edited excerpts from this chat follow. A complete transcript of this chat is available from BW Online on AOL, keyword: BW Talk.

Q: The Wall Street consensus was that there would be a second-half turnaround. Well, we're in the second half, but where is it?

A: Good question. We're all waiting. And, having waited 16 months, we're not very patient. However, I do think that we'll see a surge in the market in the [next] four months.

Q: What do you base that prediction on?

A: We track two things in the general market. The most important is the movement of mutual-fund money. We've seen growth mutual-fund money coming back into the market in the last two months. As they buy stocks, many people are selling and trying to get even. That delays the market recovery. The second thing is the negative mood all over the media -- that usually indicates a turn is nearby.

Q: Before we delve further into the market, for those who don't know what a hedge fund is and how it works, could you explain, and also talk about what distinguishes your fund from the rest.

A: Hedge funds are private mutual funds not subject to government regulation, because they're not offered to the general public. Hedge funds simply trade stocks, options, or commodities -- depending on the expertise of the manager. The Loring Fund is somewhat unusual because we only buy stocks long -- that is, we only invest during a strong market. The exception being, this year I was faked out in April, went back into the market, and am now sitting -- and holding -- a number of large-cap stocks, waiting. Just like everyone else.

Q: What's the philosophy behind your going only long, unlike many hedge funds that often short?

A: I think that shorting the market deserves your full attention and study. I would prefer to stick with one direction or the other. By buying long, I never wonder what I'm cheering for.

Q: Can you tell us what stocks -- if any -- you're buying now?

A: I'm not buying anything except a few index purchases, such as the QQQ, which is the short version of the Nasdaq 100, and also the HHH, which is an index of Internet stocks.

Q: So of the stocks you hold, what do you have the best hopes for?

A: I believe that Cisco (CSCO), at $17.50 a share, is an easy double within 12 to 18 months. Cisco has $15 billion in the bank, no debt, and they're still making money, even at a reduced rate during this economic pullback. I believe Cisco is the easiest buy right now.

Q: Any other tech stocks that might work well?

A: I also think Intel (INTC) is a good buy...and a stock that should double within two years.

Q: Are there any other sectors and stocks that you like now?

A: Right now, I would wait for the Nasdaq to get above 2250 and the Dow above 10,600 before I would be confident to buy very much of anything. We should see that, in my opinion, within the next eight weeks.

Q: Here's one on a big name that S&P has just downgraded -- AOL Time Warner (AOL) which seems like a bargain at 40. What do you think?

A: I like AOL. They're in the same boat [with other stocks] -- waiting for general market help before the stock can advance...most stocks [whether they deserve it or not] will not go up without the help of the general market. I believe AOL is a great long-term blue-chip stock, and I would buy it at any time with a five-year horizon to hold the stock.

Q: Opinion on VeriSign (VRSN)?

A: VeriSign is the former Network Solutions company, with the lock on domain names with the suffix ".com". What I like about VeriSign is that they have been determined to make money as an Internet company, and have done so for the last eight quarters. Their sales are still growing at 200% a year, and I do believe we're still in the infancy of Internet framework and services....I would buy the stock now, but have a five-year target to hold it. This is another stock that should move with the general market before the end of this year.

Q: Is AT&T (T) in any position to gain momentum in the near future?

A: AT&T is in turmoil. When a company has a number of spinoffs and buyouts going on within a year or two, the predictability of both sales and profits is all over the board...I think the stock is not going to do much for the next year, and if your interest is in the telephone business, I would look at one of the wireless companies, including the spinoff from AT&T of AT&T Wireless (AWE). Smaller stocks are more likely to have bigger moves.

Q: As a new investor, I have been advised to stay with mutual funds. Could I have your opinion, please?

A: Well, if you're going to buy stocks and expect to make money, the project requires some work -- just like any learned skill. So, buying a stock off the cuff will usually not pay off. I think, more importantly, should you choose to buy stocks, you should decide if you want to use a strategy of long-term or short-term investing, and by short-term I mean less than one year. I suggest long-term investors should read Peter Lynch or Warren Buffett, and short-term should read William O'Neil (no relation).

Q: Does that imply mutual funds might be better for beginners?

A: Thank you for saying that, because a mutual fund is run by professionals who actually are paid on the performance on the fund. They do a good job of moving in and out of the market, while we're out to lunch or on vacation.

Q: Is Gillette (G) a good buy?

A: Gillette has just finished a four-month session trading between $25 and $30 a share. The fact that the stock has held up during this difficult market is a very good sign. Unlike AT&T, Gillette pays a $0.65-per-share dividend, and would be a good long-term buy-and-hold. I do not see a lot of downside risk with Gillette from here.

Q: Consumers have been a prop for the economy -- any other consumer stocks you could recommend?

A: Well, I like Best Buy's stock (BBY). I've known the company since they began, since they're from my hometown. They have just expanded into Canada, so they are following Home Depot (HD) and Wal-Mart (WMT) in expanding across the border. Best Buy has made money for the last 14 quarters, and expects their report on Sept. 12. Watch for them to earn $0.30 a share, and if they beat that, give them your endorsement.

Q: How can an investor without the net worth required for a real hedge fund most effectively hedge his or her own investment bets?

A: Well, hedging means that you're buying some insurance, or protection, against your basic strategy. If you're a stock buyer, or mutual-fund investor, you're winning when the market goes up. The hedge against a bear market is simply to go into money-market funds or bonds, and wait out the bear market. I wouldn't mess around with options or commodities without having spent a year studying how that works.

Q: Do you see a recovery in telecom stocks?

A: I think that a telecom index fund is a great buy right now if you can wait three to five years. I have never seen a group beaten up so badly for 16 months, but the sellers seem to have run out of gas.

Q: What about the banking industry? Any names there?

A: I like the bank stocks. As the economy recovers, bank stocks are going to grow. I would look at small, regional banks with a p-e under 15, with sales and profits growing at 20% a year. TCF Financial (TCB) is a good example of the standard that you would like a bank stock to meet. Take a look at the earnings and sales record for yourself.

Q: The big lesson you give us is that we need the general market to show some vigor. But what will it take to achieve that?

A: What it's going to take isn't something that you and I can provide. The natural order of the stock market is rotation, and we have just had a very difficult 16 months of a bear market. The time to improve is coming closer, and the economy will signal us when the market is improving.

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