A short-term pause in a bull market -- that's how Pat O'Neil, manager of the Loring Hedge Fund and president of Loring Investment, sees the state of stocks today. He expects the market to resume its push upward. O'Neil suggests watching volume on the Nasdaq for a clue to the next move and says he would like to see that volume at 2 billion shares in a day, with a 2% climb in the index. At the moment, he's 35% in cash but is watching his current favorite sectors -- wireless telecom and Internet security -- and looking for the best stocks there to ride up. He likes to buy when it looks as if the market will be going up in the next two or three months.
His favorite stocks include Symantec (SYMC ) in Internet security, Medtronic (MDT ) in health care, and in financials UCBH Holdings (UCBH ), a San Francisco bank group specializing in China.
These were some of the points O'Neil made in an investing chat presented Mar. 25 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: Pat, after today, would you venture to say that the market correction is over?
A:I would like to have seen more volume today, but the fact that the Dow is holding above 10,000 is great. We'll wait for another good day like today.
Q: What do you think the trend will be for the next few months?
A:We expect that the market will continue to push upward. This looks like a short-term pause in a new bull market.
Q: What impact, percentage-wise, do you think a major terrorist event would have on the market?
A:I think the next event would have about half the correction that we had last time. The market is beginning to adjust for terrorist events worldwide. I don't see that anything positive could happen to the market, however, even as far as defense and the like go. We're living in a new financial world, with terror as the wild card.
Q: Getting back to your feeling that we're in a new bull market -- what's keeping you so positive?
A:After three years of aggressive selling, including 9/11, the market just had enough and began to turn. Bull markets usually last two to three years, with pauses during the runup. We're one year into this one, and we have taken a lot of bad news regarding jobs and earnings. I think the market has proven to be very tough -- and is showing that right now.
Q: Pat, what's your investment strategy at the moment? Any favorite sectors or stocks?
A:The last time we talked, eBay (EBAY ) was the stock that I felt had the greatest promise going forward. Now, eBay is starting to slow down, so I'd look at smaller companies, still related to the Internet. Internet security would be my favorite group.
I own Symantec (SYMC ). You might know them by the brand name Norton Utilities. They have a long history of making money in the software business and are the standard that companies are using to protect their networks from viruses and other intrusions. I like this stock as a three-year hold. It's about $45 [as of Mar. 25], and should hit $60 in 18 months.
Q: Is there any hope for AMR (AMR )?
A:I sold my last airline stock about four months ago, which was Southwest Airlines (LUV ), because I don't feel confident in any airline stock right now. I think there are better bets in technology.
Q: Can you suggest ways for an average investor with a fairly long horizon to hedge bets?
A:That's a great question, and the market is telling us right now where to go to hedge our bets. The new arrivals -- ETFs (exchange-traded funds) -- have become very popular very quickly. Index-fund investing is a great way to bet on the U.S. economy without the risk of buying single stocks. You can be technology-aggressive by buying the Nasdaq 100 (QQQ ) from any broker. This is much easier than trying to police individual stocks bouncing with good and bad news.
Q: In the wake of the European Union antitrust decision, is Microsoft (MSFT ) priced to buy now?
A:Microsoft has two very important things going for it: talent and money. I would buy Microsoft at the p-e of 21, with the goal of holding it through all these court battles, which should be resolved in the next year. I think the stock can get back to $30 within 18 months.
Q: How about Lucent (LU )? Do you think it will do well? It's getting a lot of contracts.
A:Yes, I like the Lucent recovery story. They haven't been expected to be optimistic. However, they did raise their own earnings expectation for next year. There's a lot of stock trading -- over 4 billion shares -- so it will not be easy to push up the share value, but I think it can move from $4 to $6 within 12 months.
Q: What's your take on the financial sector? And any thoughts about Thornburg Mortgage (TMA )?
A:First of all, I like financial stocks, because you can't have business expansion without money. Thornburg has been profitable for the last 10 years, and they have a lot of cash in the bank. But profits have slowed in the last year, and I wouldn't expect much out of the stock in the next 12 months. The positive side is that the $2.56 dividend is returning about 8%, and the stock price looks unlikely to go down. All in all, a dividend play.
Q: What about ExxonMobil (XOM )?
A:I don't own any gas or utility stocks right now. The top on oil stocks seems to be near, and I would look instead at profitable technology stocks over the next year.
Q: Returning to financials, what are your favorite stocks there?
A:I like a small bank group in San Francisco called UCBH Holdings (UCBH ). This company specializes in Chinese-American investing, and Chinese money coming into the country is going to banks with a hometown flavor. The stock is about $38 [as of Mar. 25], and pays a 16-cent dividend.
I've stayed away from the large financial stocks, but in that bunch, Citigroup (C ) has been making the most progress in profits in the last three quarters. If I had to buy one of the big bank stocks, it would be C.
Q: What's your opinion of gaming stocks?
A:Well, the gambling group is outperforming just about every part of the market right now, and there's no end in sight for states trying to get in on the gambling revenue. Of the group, International Gaming Technology (IGT ) is the world's largest maker of slot machines, making them a better buy than trying to pick one casino stock vs. another. IGT pays a 40-cent dividend and just raised earnings estimates for 2005. I expect it to hit $60 in 18 months (see BW Online, 3/24/04, "Tougher Odds Ahead for IGT").
Q: You pointed us a few minutes ago to "profitable technology stocks." Can you name some you like?
A:Back to Internet security stocks, there's a company, Websense (WBSN ). They make software to monitor the use of employees' Internet time during the workday. They found out that 60% of all traffic to gambling, shopping, and X-rated sites came between 9 a.m. and 5 p.m. weekdays. They now have over 300 of the Fortune 500 companies as customers, as they are trying to manage worker productivity.
Websense has a great market in front of them, because 70% of their business is done in the U.S. And because people are people worldwide, that same Internet policing is going to be necessary overseas. They have $170 million in cash, with zero debt. I like the stock to double in the next 24 months.
Q: I would like to understand your strategy as a hedge manager in dealing with this volatile market in these uncertain times. How are you allocated, and how do you hedge?
A:We're now 35% cash, and I buy stocks when the market demonstrates that it's going up in the coming two to three months. This was obvious last March: The market then pushed up about 65%. We're now in a short-term correction inside a bull market.
We watch for the strongest groups -- meaning wireless-telecom or Internet-security groups -- and as we track those groups, we look for the best stocks inside them to ride with the next wave up. We will get maybe 95% invested when the market shows us the next push has begun. I would suggest you watch the volume on the Nasdaq for this clue. We would like to see over 2 billion shares traded on one day, with the index up 2%, to tell us the next move has begun.
Q: What about stocks in the pharma or biotech or health-care areas you might like?
A:First of all let me say that I think health care is a great area to prospect for stocks. Day after day, all we hear about is the cost of drugs or medical insurance. However, this is a very big market, and profitable companies have to be identified.
In that group, I do like Medtronic (MDT ). They have been growing sales and earnings 20% a year for the last 10 years. They have a lot of cash in the bank, pay a dividend, and have a corner on implantable pacemakers. I like the stock to hit $60 in the next 18 months.
Q: After the Presidential election, will the economy improve?
A:Great question. We expect a short-term sell-off if Kerry is elected, unless it becomes apparent by the polls that he's going to be a clear-cut winner. If so, that will be factored into the market before the election happens.
Q: What about Disney (DIS ) these days?
A:Although Disney has raised profit estimates for next year, there are still unknowns about who will be running the company, and the pullback on the stock reflects the uncertainty about what might happen. I would wait for a new president before being interested in buying the stock.
Q: What about Martha Stewart Living (MSO )?
A:This is another stock with an unknown cloud hanging over it, and as you've heard for many years, the market doesn't like uncertainty. Again, I would wait until management is finalized, and then look at the fundamentals of the company before buying.
Q: Back on software -- this time, Linux -- do you like Red Hat (RHAT )?
A:Yes, I do like Red Hat, but as I understand it, they're the distributor, and not the manufacturer, of the product, which does put them at risk. However, the stock is performing well, they're making money, and are certainly in a new niche that is legitimate. I would buy a little bit of the stock and see what happens.
Q: What asset class looks best to you now, small-, mid-, or large-cap?
A:I think small caps are due for a break, and I would look at mid-cap technology and wireless telecom to find the stocks with the best opportunity for growth this year.
Edited by Jack Dierdorff