Playing the China Card

Leeb Capital Management's Stephen Leeb sees enormous markets in the Middle Kingdom and India lifting outfits like Texas Instruments and Intel

China and India are two reasons for optimism about technology stocks, in the thinking of Dr. Stephen Leeb, president of Leeb Capital Management. Leeb explains that penetration of products such as computers and cell phones in those nations is still only 1/30th of that in the U.S., which creates huge market potential for Intel (INTC ), Texas Instruments (TXN ), and similar tech companies -- even including eBay (EBAY ).

Leeb is optimistic about the U.S. stock market, but urges investors to be selective. Besides tech, he suggests energy and health care as sectors with promise. And because of concern over the dollar's weakness, he recommends investing in companies with major international exposure -- among them are his favorite techs, plus such names as Procter & Gamble (PG ), Coca-Cola (KO ), and Johnson & Johnson (JNJ ).

For the China market specifically, Leeb is high on PetroChina (PTR ) as a play both on energy prices and on what he considers an inevitable rise in the Chinese currency. He points out that PetroChina's two biggest shareholders are the Chinese government and Warren Buffett, that it is undervalued, and offers a good dividend yield.

These were among the points Leeb made in an investing chat presented Nov. 11 by BusinessWeek Online on America Online, in response to questions from the audience and from Jack Dierdorff and Karyn McCormack of BW Online. Following are edited excerpts from the chat. AOL subscribers can find a complete transcript at keyword: BW Talk.

Q: Steve, the market has done very well since the election. Are you an optimist now, and what's your outlook?

A:

I'm relatively optimistic. I don't think that this is a market you should buy with abandon, but as long as we can avoid negative surprises, such as a surge in oil prices, the path of least resistance should be up. But again, I do think it's necessary to be selective.

Q: I know one of your specialties is oil -- and crude prices have come down this week from their highs. What's your outlook? And how will it affect the equity market?

A:

I think a major reason stocks have rallied in the past week has been the decline in crude prices, and perhaps more important that crude prices hit an intermediate high -- in the mid-50s. While I don't expect oil prices to return to the mid-50s at least for three to six months, I think it would be very foolish to put oil on the back burner, [because] all the data and all the numbers and everything I look at suggest that oil, and in particular an uptrend in oil, will probably be the most important determiner of investment returns over the next 5 to 10 years.

Q: What are your thoughts on a tech bull run? Is it strong enough to run?

A:

I think selected technology stocks have a long way to run. One of the biggest misconceptions on Wall Street has been the growing importance of China and India on virtually all consumer-product companies, including a variety of critical tech products such as computers and cell phones. On a per capita basis, China and India have about 1/30th the concentration of mini technology products, which suggests unprecedented long-term opportunities in these economies for franchise players like Intel and Texas Instruments.

Thus, while in the U.S. tech probably doesn't have a lot of running room, in China and India, whose economies on a purchasing-power parity basis are already nearly the same size as ours, selected tech companies have a nearly incomprehensibly large opportunity in front of them. And again, among our favorites would be Intel, Texas Instruments, and though it's not always seen as tech, eBay.

Q: What stocks do you favor in oil and natural gas?

A:

Basically, I would view the energy sector as a diverse one and would avoid singling out one or two particular stocks, but rather try to create a portfolio from different parts of the energy universe. Among my favorites are Schlumberger (SLB ) in the oil-service industry, Transocean (RIG ) in the oil-drilling industry, ChevronTexaco (CVX ) among the integrated oil companies, and among energy producers Petro-Canada (PCZ ), and finally, for those of you who want income, and a lot of it, which has the potential to grow dramatically, I would recommend Canadian Oil Sands Trust (COSFW ). One final thought, and I can't let this stock pass by: We also strongly recommend PetroChina not only for its sure stake in energy but also because it gives you great exposure to the nearly sure revaluation in the Chinese currency.

Q: Steve, are you concerned about the falling U.S. dollar? Should investors make any changes in their holdings if it keeps dropping?

A:

I am concerned, and I do expect it to keep dropping. I certainly would have a heavy emphasis on companies with major international exposure that can take advantage of the dollar's weakness. A few names that come immediately to mind would be the tech companies I mentioned earlier -- Intel, Texas Instruments -- along with major worldwide brand names such as Procter & Gamble, Coca-Cola, 3M (MMM ), Johnson & Johnson, and perhaps even Tiffany (TIF ) and American International Group (AIG ). We also recommend at least small positions in precious-metal stocks, which tend to do well in the face of dollar weakness. Our two favorites are Apex Silver (SIL ) and Newmont Mining (NEM ).

Q: That leads right into this -- what is your feeling on gold stocks?

A:

My feeling on gold stocks mirrors my feeling about the dollar. I believe the dollar is in a protracted downtrend and that gold and gold stocks are very likely in a protracted uptrend. I want to caution this does not mean you should put 50% of your portfolio in gold stocks, but rather positions between 5% and 10% seem appropriate and are hedge enough. And, if the dollar does continue to fall, and inflation, as I expect, starts to rise, gold stocks could be entering a multiyear period in which their yearly gains are 20% to 30%, and even small positions in these risky areas will be enough to hedge a good portion of your portfolio.

Q: Are the IBMs (IBM ) and EMCs (EMC ) still the tech leaders they were? Do you see any new tech companies emerging as leaders?

A:

I don't believe EMC is a leader anymore. I think the storage area is extremely competitive, and EMC is one of many players. For IBM, it's a different story. IBM is the world's largest tech company in terms of revenues and the clear leader in a number of critical tech areas ranging from services to servers. We like the stock, though we don't own it (unfortunately), but are definitely comfortable recommending it as a critical part of a tech portfolio.

Among smaller tech stocks, probably our favorite is CACI International (CAI ). This software company provides critical information-technology services to the Defense Dept. and has become a vital part of our homeland security effort. It is a small company with a rock-solid franchise that should continue to grow at a 20% clip for the next three to five years, and possibly beyond that.

Q: If you were to invest in China, what would you go for? What companies are in the forefront?

A:

If I wanted a Chinese company, I would start with PetroChina. PetroChina as an oil company would not be overvalued were oil trading in the mid-20s. In other words, with oil in the mid-40s, by any fundamental metric, the stock is dramaticaly undervalued. It has a dividend yield of over 5%, and in case I fail to mention it, its two top shareholders are the Chinese government and Warren Buffett. To the best of my knowlege, Buffett in his entire career has never had a major position in a commodity play such as PetroChina. This is a first for him. My guess is he's not only betting on high energy prices but also, as I said before, a nearly sure long-term uptrend in the Chinese currency. But as I also said before, major international franchises, from Intel to Coke, will also benefit handsomely from strong growth in India and China.

Q: You advise investors to be selective now. Beyond energy and tech, where should we be looking?

A:

In the wake of recent election results, I think health care is a very promising area. We like a collection of health-care stocks, ranging from Novartis (NVS ) to Allergan (AGN ) to Zimmer (ZMH ) to Teva (TEVA ). Health care is a sure beneficiary of demographics. And in virtually every major economy in the world, including China, populations are aging. With a government that is fairly friendly to health care now fairly sure in the U.S., I do think health-care stocks are good medicine for your portfolio. But, as always, be selective and do your research. As the recent debacle in Merck (MRK ) proves, even great health-care companies can suffer big falls.

Q: What would you do if you hold Merck?

A:

Someone asked me that today in my office, and I said that if you back me against the wall and force me to give an answer, I would probably say hold it. But I do think there are still substantial risks. Generally speaking, whenever you have to get legal opinions as to potential liabilities, and whenever those potential liabilities could be significant, you should probably look to other investments. I think Novartis, for example, is a Big Pharma with a much clearer, maturer, much safer outlook than that of Merck.

Q: How about the financials? You referred to AIG. Do you think the President changing Social Security will be good for Citigroup (C )?

A:

I really haven't thought about how Social Security changes will affect Citigroup, but I do think Citigroup is a deeply undervalued stock -- but much more because of its huge international exposure than any benefit that might accrue to it by changing positions on Social Security. As to financial stocks in general, I think selected ones, even ones without international exposure such as Wells Fargo (WFC ), and especially Berkshire Hathaway (BRK ), are excellent investments and have long-term growth potential of 12% or more.

Q: Would you comment on the water industry and your favorites?

A:

The water industry is one that is often overlooked, and it is indeed a critical industry. This is a very good question, and thanks for asking it. The one water-related equity that we are recommending is Aqua America (WTR ). This water-based utility offers decent yield, along with the promise of double-digit long-term growth.

Q: Do you recommend any other stocks that provide income, like REITs?

A:

We recommend a variety of income plays. Three that I would single out, because not only are they income plays, and growing income plays at that, but each has a stake in alternative energy, and I think alternative energies are going to be one of the great growth industries over the next 10 years. I won't keep you guessing. My three favorites in this regard are FPL Group (FPL ), which is the leading wind producer...in addition to being a 4%-yielding Florida-based utility, and Exelon (EXE ) and Entergy (ETR ), which are the two leading nuclear utilities in the country.

Q: So, what about Microsoft (MSFT ), with all its cash and now a dividend?

A:

I think if you want income, Microsoft is not the place to look. Even with its recent dividend, you are only getting a 1% yield. Indeed, Intel, which in my opinion has a stronger long-term growth profile than Microsoft, offers greater income. That said, I think Microsoft is an exceptionally safe company and one that should be at least modestly rewarding over the long haul.

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