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Picks for a Market Stuck in Neutral

It's still a waiting game for the economy and the market until the questions swirling around Iraq are resolved. So says Sam Stovall, senior investment strategist for Standard & Poor's. Until then, Stovall believes the market is likely to remain in a depressed trading range, although he forecasts a 15% rise this year for the S&P 500-stock index.

He reports that S&P continues to recommend that investors overweight stocks in the consumer discretionary, materials, and energy sectors, in addition to a few names classified as consumer-staples stocks -- all of which should benefit from an eventual recovery. And S&P is suggesting that moderately aggressive investors be 65% in stocks, 20% in cash, and 15% in intermediate-term bonds -- reflecting caution on bonds because of the likelihood of rising interest rates.

In S&P's Top 10 portfolio, consisting entirely of buy-rated stocks, Stovall lists Alberto-Culver (ACV), Boston Scientific (BSX), Compass Bancshares (CBSS), Dean Foods (DF), IDEC Pharmaceuticals (IDPH), Jacobs Engineering (JEC), Microchip Technology (MCHP), Nabors Industries (NBR), Procter & Gamble (PG), and Wal-Mart (WMT).

These were among the points Stovall made in an investing chat presented Feb. 25 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and BW Online's Jack Dierdorff. Edited excerpts from the chat follow. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Q: Thanks for being with us again, Sam. I know you have a disclaimer to post for the audience.

A: I'm happy to be here. My name is Sam Stovall, and I am an employee of Standard & Poor's Investment Advisory Services (SPIAS). I am also a registered representative of Standard & Poor's Securities, an affiliate. Affiliates of SPIAS may provide other services to the companies that I am going to speak about. Neither SPIAS nor myself (or any member of my household) own any common stock in the companies that are discussed in this chat. I am not affiliated with any of the companies that will be mentioned during this chat. Investors are advised to discuss any investment in detail with their financial adviser.

Q: Glad you're here, Sam -- but is there anything in the market's prospects for us to be happy about?

A: Well, certainly today's turnaround indicates that there are still some bargain hunters on the sidelines who are willing to step in when prices get too low. But until we get the geopolitical uncertainties behind us, we're likely to remain in a depressed trading range.

Q: Your opinion, please, on BellSouth (BLS)? Do any telecoms look good?

A: S&P currently has an underweight recommendation on the telecom sector. We still believe that there's a lot of capacity and competition in the marketplace and have only one stock ranked buy (or 5-STARS) according to S&P's Stock Appreciation Ranking System [STARS]. This stock is Alltel Corp. (AT). Boston Communications Group (BCGI) is ranked 4-STARS (accumulate), whereas all other wireline and wireless telecom stocks are ranked hold, avoid, or sell. BellSouth is...ranked 1-STAR. or sell.

Q: What do you think of Qualcomm (QCOM)?

A: We have Qualcomm ranked 3-STARS, or hold. We have a neutral ranking on the telecom-equipment industry in which Qualcomm is found. We have no stocks ranked accumulate or buy in this category. But we see the QCOM shares earning $1.39 in fiscal 2003, rising to $1.56 in 2004.

Q: Do you have a crystal ball that can see D.C.? Is Congress going to cut the taxes on dividends? And if so, what kind of market impact do you see?

A: We think it's likely that Congress will reduce the tax rate to be equal to that of the long-term capital-gains rate, but we think it's less likely to eliminate the tax on dividends altogether. Some of the higher-yielding sectors include utilities at 4.8%, telecom services at 3.4%, and energy, consumer staples, and financials at 2.4%.

On an individual industry basis, tobacco stocks yield 6.8%, electric utilities yield 4.9%, and commodity chemicals yield 5.5%.... [A tax cut] should benefit stocks because it would give investors an additional reason to own equities.

Q: Sam, does S&P rate itself?

A: S&P does not rate itself for obvious conflict-of-interest reasons. However, a company named Investars Research has recently issued a report stating that since 1999, S&P's research was rated No. 1 on a one-, two-, and three-year basis. And if you don't want to take my word for it, please visit

Q: What do you think of Honeywell (HON)?

A: We have the Honeywell shares ranked 3-STARS, or hold. Despite selling its Bendix brakes-parts business, we don't think Honeywell is completely free of continuing asbestos liability. On the other had, we don't see the company in mortal danger either. We just see the shares as trading near our fair-value appraisal.

Q: Your opinion on Bristol-Myers Squibb (BMY)? How about pharmas generally? And what's your favorite health sector stock?

A: Let's take it from a top-down standpoint. We're neutral on the health-care sector, which we recently raised from being negative -- aided by relatively strong financial prospects, high earnings quality, and investor rotation.

We believe Medicare drug benefit and patent expiration concerns are already embedded in pharmaceutical valuations. Bristol-Myers carries a 2-STARS, or avoid, ranking, but we do have several health-care stocks that carry our buy or 5-STARS ranking. They include (but are not limited to) Eli Lilly (LLY), Amgen (AMGN), Boston Scientific (BSX), Cardinal Health (CAH), and Barr Labs (BRL).

Q: Do you think AOL Time Warner (AOL) will ever rebound?

A: Yesterday we reiterated our hold, or 3-STARS, ranking on the AOL Time Warner shares. We weren't surprised to hear that AOL may sell a majority stake in Warner Music, since the industry has been in a protracted downturn. In fact, the divestiture would be consistent with AOL's strategy of divesting noncore assets, mainly to pay down debt. We would hold the AOL shares, since they're trading at a valuation level that's below their large media peers.

Q: How do you feel about U.S. Bancorp (USB)? Your view on financials?

A: We're neutral on the financial sector and believe that the group has earned all it can as a result of lower interest rates. We're also neutral on large banks in particular, since they still contend with a weak credit-quality environment, sluggish loan growth, and a difficult capital market.

Yet many times you can still find some stocks to favor, and such is the case with U.S. Bancorp, which we have ranked 4-STARS, or accumulate. The company posted earnings of $1.73 last year and is expected to earn $2.05 this year.

Q: Which munitions maker will benefit from Iraq and the ongoing terrorism? Or any other type of company?

A: I'm sure that there are some small pure-play stocks that could benefit directly from contracts with the Pentagon, but our recommendations are primarily based on large, multidivisional companies that are more likely to benefit from an improving economy and rebounding earnings, once the conflict with Iraq has been resolved. (That might be a very fancy way of saying: "No specific names come to me at the moment.")

Q: Moving into tech -- I like Dell (DELL) for the next three to five years. Do you?

A: I can only tell you what our 6- to 12-month investment outlook is, and that is that we believe the shares are worth holding at this point. We recently reiterated our hold recommendation due to in-line earnings.... The shares are trading at 24 times our 2003 operating estimate, which is pricey when compared with its peers, but we still feel the low-cost producer is worth holding.

Q: How about the rest of tech, Sam?

A: The technology sector currently carries an underweight recommendation, yet the number of stocks that we favor in this sector has been rising. Some stocks in this group that we favor include Analog Devices (ADI), Cisco Systems (CSCO), Fair Isaac (FIC), Sybase (SY), and Symantec (SYMC).

A previous questioner asked what companies could benefit from the possibility of increased terrorism, and we have found Symantec to be a company that has benefited every time we hear about new viruses that are floating around the Web. So while not your typical arms manufacturer, it is a company that helps people fight off a different kind of terrorism.

Q: What sectors does S&P give higher weight to now?

A: We're still focusing on the economically sensitive areas that should benefit from an economic recovery and earnings rebound once the Iraqi situation has been resolved. Consumer discretionary, materials, and energy are favored, along with selected industries within consumer staples.

A few companies of interest include Lear Corp. (LEA), Dean Foods (DF), Apache Corp. (APA), Nabors Industries (NBR), and Nucor Corp. (NUE). All of these companies are ranked 5-STARS and are included in the sectors that I mentioned. Two companies that are found in the utilities sector (but could easily be mistaken for energy companies) include Questar Corp. (STR) and Kinder Morgan (KMI).

Q: What's your forecast for the S&P over the next year?

A: We have a yearend 2003 price target of 1005 for the S&P 500 and 1535 for Nasdaq. Both values represent a 15% increase over yearend 2002 values.

Q: Sam, last time you were here, you mentioned a portfolio of picks suggested by S&P, I believe. Is it still there? And any changes?

A: I might have mentioned S&P's Top 10 Portfolio, which consists of 10 5-STAR stocks selected by our director of equity research. Some recent additions include Jacobs Engineering (JEC), Alberto-Culver (ACV), and Compass Bancshares (CBSS) -- they, along with Boston Scientific (BSX), IDEC Pharmaceuticals (IDPH), Dean Foods (DF), Wal-Mart (WMT), Microchip Technology (MCHP), Nabors Industries (NBR), and Procter & Gamble (PG). That should equal 10. I don't have an end-of-February tally, but the Top 10 list lost 1.4% in January, vs. a 2.8% decline for the S&P 500.

Q: And now asset allocation -- what's your ideal portfolio breakdown?

A: S&P is recommending for moderately aggressive investors a 65% exposure to equities, a 15% exposure to intermediate term bonds, and a 20% exposure to cash. Because of a likely rising interest rate environment as the year progresses, bonds could be hurt more than stocks.

In addition, since the dividend yield on the S&P 500 is about twice what an investor would get in an average money-market fund, even if stocks went nowhere, investors would get a higher return than by holding cash. Near-term, stocks will likely remain in a depressed trading range until the Iraqi situation has been resolved. But we think that through the course of the year, a recovering economy and rebounding earnings will ultimately reward the patient equity investor.

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