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"My Expectation Is We've Seen the Lows"

Christmas will be catch-up time for consumers and should start the economy toward recovery, according to Milton Ezrati, senior economic strategist for Lord Abbett & Co. He thinks the first quarter of 2002 will show definite signs of that rebound.

For the stock market, Ezrati believes there will still be some erratic behavior, but says "my expectation is that we've seen the lows." He defines himself as a value investor and sees that style of investing remaining successful for some time to come, with small-cap and mid-cap value stocks leading the way.

Among specific stocks, Ezrati likes low-end retailers such as Target and J.C. Penney, regional banks such as Wachovia, and a few transportation names -- Union Pacific and, "if you have intestinal fortitude, American Airlines."

Ezrati made these comments as a guest in a chat presented Oct. 4 by BusinessWeek Online on America Online, in response to questions from the audience and BW Online's Jack Dierdorff and Karyn McCormack. Edited excerpts follow. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Q: Milton, the big question for all of us is when the economy will hit bottom and start up again -- and ditto for the stock market. At least it has edged above 9000. What are your thoughts?

A: Well, on the economy, I think it's important to realize that there were signs of recovery in the third quarter before the September 11 attack. As a consequence, there is a hiatus here because of the attack. It will probably last a month or two, barring some other shock, and we should see those signs of recovery returning in the closing months of the year.

I think the consumer for Christmas will probably catch up a little bit for what he's missed in this latest period. It will become truly apparent that the economy is on a recovery path in the opening quarter of 2002. For the market, we will probably see a very erratic pattern, but my expectation is that we've seen the lows.

Q: A few of the tech stocks have suddenly started to look better. What's your outlook for that sector?

A: Activity in the tech sector will probably wait until spring or summer of 2002 to make a definite upturn. Tech is definitely the lagging sector in the economy today. On the stocks, there is some value we're finding in some of the semiconductor names, but it's a little premature to overweight tech in a portfolio right now.

Q: What sectors seem strongest between now and the end of the year?

A: I think the best bet between now and the end of the year is in the retail area -- particularly the low-end retailers. There are tremendous values also in transportation and in banks. I would stay away from tech, as I said, and from oil.

Q: Thoughts on the financial sector -- and specifically Merrill Lynch (MER)?

A: Merrill has upside potential with the market's recovery, but there is probably greater potential within the financial sector, and much less potential volatility, in the regional banks -- Wachovia (WB), Bank One (ONE), and money-center banks that have large exposure, like Citi (C). I prefer them to investment banks and the brokers.

Q: Could you share some names in the transportation sector that look especially good?

A: We're using two names in our portfolios -- Union Pacific (UNP) in the rails, and if you have intestinal fortitude, American Airlines (AMR). Trucking companies look attractive, but we tend to only buy large capitalizations, and none of them are big enough.

Q: And what about the low-end retailers, another group you said you liked?

A: We're using names like Target (TGT) and J.C. Penney (JCP). Wal-Mart (WMT) might serve, but it's not a name in our portfolio.

Q: Another type of retailer -- what are your thoughts on Rite Aid (RAD)?

A: Rite Aid fits the pattern that we like. We're not using it in the portfolio, but it certainly fits the pattern.

Q: Milton, what do you think about pharmaceutical stocks?

A: I think the pharmaceuticals are vulnerable to the legislation in Washington that has been put on hold because of the terrorist crisis. But it will come back. I would buy names that have very broad research efforts and good patent protection. Names that are too focused on a single product, especially in this legislative environment, are risky. I would say Pfizer (PFE) is the best bet -- it's the name we're using.

Q: What do you think of bonds right now? And which type do you think attractive?

A: I think that Treasury bonds are probably a bad bet right now. Looking out 12 months, at best on Treasuries you will get the coupon. But there are tremendous opportunities in corporate and municipal bonds. Corporate bonds are offering historically wide yield spreads over Treasuries. On high-yield bonds you're getting more than 10 percentage points above Treasuries of comparable maturity. If, as I expect, the economy recovers, default rates will decline, spreads will shrink, and these bonds will give you a capital gain on top of an already generous current yield. Municipals have a little more complex story, and we can go into that if you'd like.

Q: Why don't you? The triple tax-exempt feature appeals to many.

A: Municipal bonds today, for the individual investor, are very hard to get and especially hard to get good prices on. But funds and institutional investors are getting prices that make these bonds very appealing. The average AAA or AA municipal bond today, if you were to gross up the yield for the maximum tax rate, is offering near-junk rates for a quality credit. That's very attractive. Everything I said about the corporate bonds, therefore, applies in the municipal area.

But more than that, states and municipalities across the country find themselves in excellent financial shape -- and are not issuing bonds. So the holder of a municipal bond not only has the attraction I described for corporate bonds, but also has something that will acquire a scarcity value going forward. Because of the nature of this market, however, the only way to get these attractive prices and yields is through a fund.

Q: When do you think there will be enough of an uptick in corporate earnings to rally the stock market?

A: I think the stock market will rally before we see the uptick in corporate earnings. We will probably see extremely poor earnings reports for the third and fourth quarters this year -- that's widely expected. The market has begun to look at 2002, and if, as I expect, the economy shows signs of coming back, the stock market will gain positive momentum in anticipation of those 2002 earnings reports. Keep in mind that the year-ago earnings comparisons in 2002 will be very easy, and that leaves room for positive surprises.

Q: Back on tech, what about Sun Microsystems (SUNW)?

A: I think there are better, more reliable ways to make money. Sun has fine products, but the stock remains expensive, even after all its troubles. I think it's worth keeping in mind that historically, when a stock bubble bursts, the names involved (like Sun) take years to recover their dollar value, and never recover their relative pricing.

Q: So what do you recommend for people with big paper losses in tech?

A: I think if they're not diversified, they should be, and they should let Uncle Sam help them with the losses and make that diversification. Simply holding a skewed portfolio is an exercise in hope, not planning. If tech is a portion of their holdings, then they're in a position to wait, but if it's a big portion of their portfolio, it's in their interest to diversify.

Q: Which of the Lord Abbett portfolios has held up the best in recent months?

A: The portfolios that have done the best in recent months are our mid-cap value portfolio and our Treasury-bond portfolio.

Q: What are some of the top holdings in the Lord Abbett mid-cap value fund? Do you think that arena will continue to do better than others?

A: J.C. Penney is one. We believe that the mid-cap and small-cap value stocks will lead the market.... If you want to check the holdings, you can go to and look at the portfolio there.

Q: Do you consider yourself a value investor? Do you think that investing style still has legs for some time to come?

A: Yes, I am a value investor. Lord Abbett offers both growth and value funds, but its reputation is in value. I think value has legs for at least two reasons. One is that the legacy of the '90s is that most individual portfolios are still highly skewed toward growth, and there is a need to revalue them. That will support value stocks going forward.

The second reason is that the timing of the investment cycle still very much favors value. Value tends to outperform in the downswing of the cycle and in the initial recovery phase of the market. The only time growth leads in the investment cycle is in the late phases of the cycle, and we are a long way from that now.

Q: How about telecom? It has been in the doghouse -- any names?

A: We're using WorldCom (WCOM). The sector as a whole looks cheap. The issue is to find names that will survive.

Q: What are your thoughts on Allstate insurance (ALL)? And how about insurance in general, post-WTC?

A: Allstate's fine, but there are better buys, especially after the WTC disaster. Chubb (CB) is the name we're using.

Q: Where do you stand on the question of whether the Fed is pushing on a string with its interest-rate cuts?

A: The Fed is NOT pushing on a string, and there is strong evidence in the housing market of what the Fed has already done. Real estate prices nationally are up 9% from a year ago. That's an indication of how powerful the effect can be, and will be as it moves through the rest of the economy. If anything, the Fed has pushed too hard -- and will probably have to reverse itself in the second half of 2002.

Q: Software companies like Oracle and Microsoft are still growing their bottom lines. Why do investors seem to prefer companies with no earnings to names such as those? Where do you stand on ORCL

and MSFT


A: Well, Microsoft and Oracle are fine companies, and they're in critical areas. They have been impressive in their ability to grow their bottom lines. For a value investor, however, they still seem a little pricey. I can't be sure why people prefer companies without earnings to companies that have earnings. It seems a little irrational to me. My guess is they're trying to hit a home run -- it strikes me more as gambling than investing.

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