By Gene Marcial
Justified or not, lots of investors have grown wary of the stock market. And many market watchers and investment managers have, at best, turned fickle toward stocks. Worry that the Federal Reserve's next move will be to raise interest rates has made them jittery. And despite several signs to the contrary -- the fall in unemployment, rising productivity rates, and increased consumer spending -- they aren't so sure that the economy is out of the woods.
But not everyone is so fearful. Veteran market strategist and avid Fed watcher Bert Dohmen is pounding the table for stock investing: "The current environment is terrific for investing in the stock market," argues Dohmen, who's editor and publisher of the Wellington Letter in Los Angeles.
In early 2000, Dohmen was terribly bearish on the market, but he turned bullish on Sept. 24, 2001, when the surprise and unexpectedly strong post-September 11 rally started. He thinks the market's pullback in mid-January that followed the fall 2001 rally ended in late February.
He notes that despite the drag in the major stock indexes since January, the majority of stocks have done much better. "Over the next 6 to 12 months, we should have another period of optimism where certain sectors of the stock market will do very well, and the economy will grow robustly," predicts Dohmen. His forecast of better times comes amid efforts by many institutional investors to rework their portfolios in anticipation of the Fed's possible switch in policy toward credit tightening.
However, Jeffrey M. Applegate, investment strategist at Lehman Brothers, warns that it would be premature to position portfolios now for the next round of Fed rate increases. "With inflation falling and productivity growth rising over the next few quarters," he says, "the Fed is unlikely to get agitated about an inflation problem in the pipeline."
Applegate argues that during post-recession periods in the past, the Fed has never ever tightened before the unemployment rate stabilized. Lehman's economics team, he says, expects the jobless rate to peak at 6% in the summer. Should that happen, he says, the Fed could then start raising the Fed funds rate in 25-basis-point increments, possibly starting in September.
Dohmen doesn't preclude the possibility that the Fed may raise rates later this year "under the false assumption that it must cool the economy in order to prevent inflation." But he argues that the Fed may not wish to rush into raising rates for one specific reason: The two areas that have supported the economy over the past five months were the stock market and real estate/housing. Dohmen argues that if either of these, or both, start nosediving because of higher interest rates, "the Fed can kiss the recovery goodbye."
Asks Dohmen: "Would the Fed risk breaking the back of the recovery -- after having been blamed for creating the recession and a devastating bear market?"
In the meantime, Dohmen thinks the old-economy-type of stocks will outperform the technology group, and that the Nasdaq Composite index, which is dominated by large-cap tech stocks, will be locked in a wide trading range. So he's advising investors to be in the defense, homebuilding, hotel, discount retailer, and family-restaurant-chain sectors.
In defense, Dohmen favors contractor Raytheon (RTN ), currently trading at 39 a share, and L3 Communications (LLL ), which supplies secure communications systems to the U.S. defense and intelligence services, and to aerospace contractors. The stock is trading at 107 a share.
In homebuilding, Dohmen likes Toll Brothers (TOL ), a major builder of luxury homes, now at 50. And among hotels, Starwoods Hotels & Resorts (HOT ), one of the world's largest hotel/lodging companies, is at the top of his favorite stocks list.
Among discount retailers, Dohmen is high on Costco Wholesale (COST ), which operates more than 360 membership warehouses, currently trading at 39. Also on his list is Ross Stores (ROST ), a chain of off-price retail outlets, trading at 37.
"DON'T BE MISLED."
And among restaurant chains, Dohmen's top pick is little known P.F. Chang's China Bistro (PFCB ), which owns and operates a chain of Chinese restaurants and a string of casual-dining Chinese eateries. The stock is trading at 66 a share (see BW Online, 1/30/02, "P.F. Chang's Sweet and Sour Outlook").
Dohmen concedes that the major stock market indexes, such as the Dow Jones industiral average, the Standard & Poor's 500-stock index, and the Nasdaq Composite, aren't looking very impressive at this point. But "don't be misled," he says. The U.S. stock market, he agures, "is in excellent shape." He points out that the advance won't show a straight line up, but it will rise "slowly and surely, with conviction." And, predicts Dohmen, this bull market will yet "confound all the naysayers."
Marcial is BusinessWeek's Inside Wall Street columnist