By Gene Marcial Investors are perplexed: Is the economy steaming toward a recovery? Is the recession really behind us? Whether or not the slump is now over may not be known for quite some time because the official arbiters of such events need months of data before they decide. In the meantime, what can investors do?
To some professional market advisers, it's high time to buy stocks -- selectively. One pro who delivers such advice is Stephen Leeb, editor of the Personal Finance market newsletter in McLean, Va., and president of Leeb Capital Management.
"An upturn is very near, and the odds on big returns from select stocks are about as favorable as they get," says Leeb. Stocks that have been badly battered, either by fears about the weak economy or about a much-delayed recovery, will be among those that will snap back sharply when the rebound comes, argues Leeb.
HISTORY LESSONS. He says the evidence is compelling. The most reliable leading monetary indicators, reports Leeb, are showing favorable signals. Money growth is very positive, posting the fastest rise in recent history, he believes. The spread between long- and short-term interest rates has been historically wide, which he sees as a favorable sign. And the stock market has staged an "impressive rally" since Sept. 11 -- another big plus.
Leeb notes that history tells us that given such a rally, "the beginning of a recovery has never been more than several months away." He estimates that an upswing will arrive sometime in the current first quarter.
What happens then? "Again, history tells us that stocks rise a lot," says Leeb. Past data also show that the small-cap stocks do better than the big-caps in the first year of an economic recovery. That's because they're "more leveraged to the economy's impending growth," he explains. Leeb is traditionally a big-cap, growth-stock investor, but now he has loaded up on small-caps.
A VERY GOOD YEAR. On average, the S&P 500-stock index has gained in the first year of a recovery more than 22% -- about twice its historical average yearly gain, notes Leeb. Small-caps, however, did better with an average yearly gain of 37%.
Leeb notes that the S&P 500 jumped the most in the first year of the economic recovery that began in April, 1958, when it advanced 37.3%. Small-caps, he adds, soared 53.5%. The smallest rise in the first year of an economic rebound occurred in the rebound started in July, 1991, when the index rose 12.8%, and small-caps climbed 17%.
Leeb's core portfolio of 35 to 40 stocks has outperformed the S&P each year in the past three years since 1999, gaining 13% on an annualized basis, while the S&P lost 2.7%.
Here are his current top picks:
ACE Ltd. (ACE), a property-and-casualty insurance holding company, trading at 35. Nabors Industries (NBR), a large global land driller of oil and gas, currently at 27 a share. North American Palladium (PAL), a Canadian explorer for platinum and certain base metals, now at 6 a share. NRG Energy (NRG), a Big-Board listed global company that acquires, develops, constructs, and operates power-generation facilities, trading at 13. And Solectron (SLR), a global contract manufacturer in the electronics industry, trading at 11.
"SWIMMING UPSTREAM." ACE's stock, like that of other insurers, was devastated by the September 11 attacks: It plunged from 35 a share in August to 18 on Sept. 21. It has since snapped back to more than 35. ACE is well positioned to benefit from a recovery, says Leeb, as it's well capitalized and is able to generate underwriting profits even when "swimming upstream."
With its "exceptional management and global presence, ACE will see earnings soar in this tough environment," says Leeb. He estimates earnings will jump to $4.50 a share in 2003, up from an estimated $3.69 in 2002. ACE is expected to post a loss of 18 cents a share in 2001 as a direct resulting of September 11, says Leeb.
Nabors Industries has been battered by the drop in oil and gas prices, with its stock plunging from 63 in January, 2001, to 18 on Sept. 21. It has edged back up to 27. Leeb thinks the stock will exceed its high in the next 18 to 24 months, when he expects energy prices to head back up, in part due to the recovery.
ATTRACTIVELY VALUED. NRG Energy has recently been tainted by the Enron bankruptcy -- like other independent power producers. But NRG has "virtually nothing in common with Enron," insists Leeb. Still, NRG shares have fallen from 37 on Mar. 30, 2001, to 9.70 on Dec. 12, partly due to the Enron scandal.
Now at 13, the stock is attractively valued, argues Leeb, for two reasons: Xcel Energy, which controls 70% of NRG, could buy the NRG shares it doesn't own, as it had hinted recently. And the industry shakeout resulting from the Enron banktruptcy will reduce the number of power plants that will be built.
The reduced supply of electricity against demand is a plus for NRG, says Leeb. He figures it'll easily meet earnings targets of $1.70 a share in 2002 and more than $2 in 2003. Earnings for 2001 are estimated at $1.35.
CLEAN-UP PLAY. North American Palladium is the continent's lowest-cost palladium producer, and its stock has also been beaten down, from 41.95 in early January 2001, to 9.65 on Sept. 21, and is now at 11.36. Industrial metals, says Leeb, will be a big beneficiary of the recovery, such as the platinum-group metals, or PGMs. Palladium and platinum are vital components in catalytic converters, used to filter pollutants from auto emissions.
Leeb says if PGM prices recover even just slightly, North American could earn $1 (Canadian) in 2002, up from an estimated 32 cents in 2001. The stock could double in 12 months, says Leeb.
Solectron, whose stock has also taken a fall -- from 42 in January, 2001, to 9.65 on Dec. 21, and still around 11 today -- is also a recovery bet. "Few tech stocks have as much upside leverage as Solectron," says Leeb, who expects it to hit 18 within 12 months. It will be driven by the increase in outsourced manaufacturing by big-name electronics companies, he says, as well as by the recovery.
If Leeb is on the money, this prerecovery stage of the market could provide plenty of opportunities -- especially in the battered fields of insurance, energy, and technology. Marcial is BusinessWeek's Inside Wall Street columnist