The coming year will be a "stock-picker's market," says Dan Chung, president and chief investment officer of Fred Alger Management, a New York investment firm with $10 billion under management. With the U.S. expected to grow by 3% to 4% and the global economy projected to expand nearly 4%, high-quality companies will continue to deliver double-digit profit gains even if corporate earnings slow, believes Chung.
He and Zachary Karabell, a senior economic analyst and portfolio manager of the outfit's China-U.S. Growth Fund, recently spoke with BusinessWeek Online Correspondent Beth Carney about rising commodity prices, promising leisure companies, and why China's growing power will be good for American businesses. Below are edited excerpts from their phone conversation. (Editor's note: Alger Management has positions in all the companies that it recommends.)
Q: What's going to happen with the stock market in 2005?
Chung: We think we're likely to see a year pretty similar to this one -- high single- to low double-digit returns. We're a little more optimistic than the consensus view. In the first half of 2005, the market could be quite strong. We're seeing a rally now that's a little bit of a harbinger of what early '05 will look like.
In a lot of ways, '04 was very positive for corporate earnings, but the market underperformed, we think largely because of externalities -- sentiment about elections, Iraq. Next year, although earnings growth isn't going to be as strong on a relative basis, the absence of those external forces should free up investors' attention.
Q: We've been in a trend of rising energy and commodity prices. How should that affect investors' strategy?
Chung: An investor will be wise to have a reasonable allocation of their portfolio in energy-sector, commodities-related stocks. We're going to see exploration activity, hopefully also alternative-energy activity.
As the market adjusts to higher energy prices, it's going to [change the way people look at] a lot of things. For example, we're seeing increased interest in liquid natural-gas projects. Natural gas has been burnt off in a lot of Middle Eastern and African countries as a byproduct of oil extraction. The reason is that the process of liquefying it and transferring it was costly. At current prices, those projects are [now considered] viable.
Karabell: There are interesting ways to play some of this that don't involve buying gold or the commodity themselves. There are companies that supply equipment to the exploration companies and the energy technology companies.
Q: What's the safest way for an investor to play this trend?
Karabell: For an individual investor, trying to buy or sell copper or coal futures or oil is very tricky. There are obviously much safer ways to [invest in the sector] -- by investing in solid companies that benefit from higher commodity prices but have a long-term business.
So, companies like British Petroleum (BP), which has, in our view, the best global prospect for exploration across the integrated oil companies. Another example is National Oilwell (NOI). They provide a lot of oil rigs with big heavy capital equipment that happens to last decades. They're in the relatively early stages of a multiyear cycle of expansion.
Q: China, with its huge supply of cheap labor, is seen as a great threat to American manufacturers and a reason for the recent loss of manufacturing jobs. Is that the correct impression?
Karabell: We think that that picture is incorrect. One of the things we've been trying to emphasize is that the loss of American manufacturing jobs has been going on for decades. And most of the jobs that China is now creating are at the detriment of places like Malaysia, the Philippines, and Mexico.
That's not to say there aren't some [U.S.] jobs being lost to China, but it's much less than the media and the popular perception would suggest. Many of the jobs that are being lost in manufacturing are being lost through productivity -- through computers or machines.
Chung: For example, take bank tellers. That used to be a booming career for a lot of young college graduates as a way to become a bank manager. Online banking and ATMs have taken over, and direct deposit means we don't have to wait in line any more. There's no Chinese guy taking that job from an American.
Q: If its role is misunderstood, how should people be thinking of China?
Karabell: We should really be thinking of China as a global consumer. The U.S. has been the consumer of last resort and, in a lot of ways, the world's shopper since World War II. That has led to a high dependence on the ability of the American consumer to buy.
It's a lot to expect 200 million-plus American consumers to supply the growth of 6 billion humans on the planet. The emergence of China as a consumer power is a real positive for the global economy. And we're in the really early stages of that emergence.
Q: How can thinking of China as a consumer nation inform an investing strategy?
Karabell: China is looming large as a booming new market for what are usually considered domestic American companies, whether it's a company like FedEx (FDX) looking for an area of expansion and finding it in air freight from China, or energy companies. Energy companies may or may not directly deal with China, but the effect of China on the consumption of oil has an effect on the entire industry.
One of our guiding philosophies is to look for areas of change. That's where you can get the maximum upside. China for us is a significant area of global change, as are the continued effects of information technology and the innovations of biotech.
Q: What do you think is going to happen with the dollar?
Karabell: We tend to feel that the dollar is an overemphasized investment theme. We're more interested in how companies themselves are managing foreign exchange.
Q: Any general advice about investing strategies in the coming year?
Chung: You have to be quite objective about where the opportunities are. We don't think all consumer stocks will do great next year. The consumer is definitely under some pressure in terms of discretionary spending because of the high energy prices. We're not big fans of many of the retailers.
On the other hand, travel and leisure we do like quite a bit. As baby boomers age, they've got all the cars, they've bought a lot of real estate, but having a good experience is still highly valued. That's why Las Vegas is doing well, Carnival Cruises (CCL) and Royal Caribbean (RCL) are doing well, hotels are doing well. We like Hilton (HLT). We like Disney (DIS). We like most of the media entertainment companies, like Time Warner (TWX).
We do think it's a good stock-picker's market and one that will be up -- but one that will require you to go into each company and try to think what the winners will be.