"It's time in the market, not timing the market, that makes a difference." That's a lesson offered for investors in 2005 by Joseph Battipaglia, executive vice-president and chief investment officer of Ryan Beck & Co. He cites the example of 2004, when all the money was made in the last quarter -- rewarding patience.
However, Battipaglia cautions that investors should also seize the opportunity to sell stocks whose valuations are not "sustainable." Broadly, looking further ahead in 2005, the legendary bull sees the Standard & Poor's 500-stock index advancing "at least" 10% in a year when large-cap stocks will be the most interesting, partly because of global expansion, the weak dollar, and more attractive valuations.
Among sectors, consumer nondurables appeal to Battipaglia. Consumer appetites for durable goods such as autos and homes have been fairly well satisfied, in his view. So Battipaglia looks more to companies such as Procter & Gamble (PG ), Johnson & Johnson (JNJ ), Sanderson Farms (SAFM ), and Electronics Boutique (ELBO ).
These were some of the points Battipaglia made in an investing chat presented Jan. 6 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff and Amey Stone. Edited excerpts follow. AOL subscribers can find a full transcript at keyword: BW Talk.
Q: So, Joe, how bullish are you for the market in this new year?
A:It will be a year where the S&P 500-stock index advances by 10%, at least. The real exciting story for investors will be in the large-cap arena. The larger companies will benefit from global expansion and the weaker dollar, and valuations for us are more attractive in this area than in small- and midcaps. In the bond market, it will be a tough year. For whatever you earn, you'll sacrifice almost the same in capital, as interest rates rise across the board. We expect the 10-year Treasury to go to the 4.25%-to-5.25% level.
Q: Why do you think the market has gotten off to such a rocky start so far this year?
A:I think investors have learned their lesson from the 2004 market. That had terrific momentum in the first few months of the year, which gave way to an eight-month downdraft. So given the strong rally from the October, 2004, lows, I'm not surprised that we're getting hesitation now as investors wonder what earnings will look like from major corporations. They also wonder what kind of energy environment we'll face this year, which is encouraging so far. Thirdly, we have to get used to a more aggressive, less accommodating Federal Reserve.
Q: Joe, how was your performance in 2004? What stocks or sectors did best for you?
A:We're very happy with what we accomplished in 2004. Our S&P 500 target was 1,180, our Dow was 11,000, so we came quite close to hitting those marks. We had expected interest rates to be higher on the 10-year Treasury, which didn't materialize, but we had anticipated correctly that the Fed would raise interest rates to the level where they closed the year. Some sectors that worked best for us in 2004 were consumer nondurables (I'm looking at our numbers) and energy.
Q: Lots of negative news about some big pharmas: How do you feel about Pfizer (PFE ) at this point in time?
A:It would appear that Pfizer is trading based on the worst expectations, both in terms of its underlying growth rate and its handling of the Cox-2 inhibitor debate. And it probably can work its way toward higher ground from this level, given that the legislative environment will be less hostile in the second Bush term.... I, for one, am not prepared to count out these very large, financially sound international pharmas.
Q: What is your outlook for the chemical industry in general -- and Air Products & Chemicals (APD ) in particular?
A:I'm bullish on the outlook for APD. I believe the industrial demand for their products will continue to expand. It's trading at an attractive valuation. As for the chemical industry in general, persistently high energy costs have presented a problem for these companies, along with an even demand profile in the developing world, particularly in countries like China. So it may be more of a choppy road for commodity chemical producers.
Q: How about the tech stocks? Your thoughts on Hewlett-Packard (HPQ )?
A:Technology is a sector in 2005 that will have the same problems that it had in 2004. The bellwethers like Microsoft (MSFT ), Oracle (ORCL ), Cisco Systems (CSCO ), etc., will have more subdued growth rates and fairly high multiples, making the stocks unattractive...As for HP, I'm still a believer that their CEO's [Carly Fiorina's] program of innovation between Compaq and HP will be successful. They've disappointed us in the last quarter, but I believe they'll show good numbers in the quarters ahead, and I see no reason why the stock price couldn't go to its old high of 26.28.
Q: Plain and simple, what would be your top stocks for 2005?
A:In no particular order: Stocks to consider this year include Sanderson Farms (SAFM ), Western Digital (WDC ), Agrium (AGU ), Electronics Boutique (ELBO ), Centennial Communications (CYCL ), Capital Title Group (CTGI ), and Lifecell (LIFC ). We own these stocks, by way of disclosure. And that names just a few of our portfolio holdings.
Q: How do you feel about regional banks such as Hibernia (HIB )?
A:We have a very favorable view of regional bank stocks. We believe their high price-earnings (p-e) ratios, by historic measures, are justified as this industry consolidates and the growth rates for survivors accelerate. Now, there are parts of the banking industry that will obviously weaken in the face of rising rates, particularly savings-and-loan associations, and those banks with big percentages in the residential-mortgage business. But the regional banks of which you speak should be considered the sweet spot for one's financial-services exposure. Hibernia is one of many good ones to consider.
Q: Your overall feeling about international stocks and the dollar?
A:Easy question, complicated answer. Let's talk about the dollar first. I think the dollar is oversold against the euro, should drift lower against the yen, and will drift lower against the yuan as they change the peg there. Rising rates will help, as will action regarding the deficits that exist today, which should mitigate some of the negative expectations about that. The lower cost of energy may help as well since the energy cost is in dollars and has meant more dollars out this year than typical, as prices have risen so dramatically.
One thing we've discovered about international markets is that as you look at averages, they're never in synch with the American market. So you can't really get a countertrend move by diversifying internationally. For the highest beta, though, the emerging market seems to be the best place in 2005, on the theory that global expansion will include them as well, investor risk-taking is on the ascent, and these markets, which are relatively small in their singularity, should move rather sharply as these trends play out. The other markets are not necessarily the best place to be in 2005. Japan falters in and out of expansion, Europe is no sure thing.
Q: Joe, are you worried about the real estate market at all, since your forecast is for rising interest rates and higher mortgage rates?
A:Yes, when it comes to the real estate market, we've cautioned investors that the homebuilders may well run into peak earnings, and as a result we've been recommending taking a profit in this group. This relates back to the point we made about cycles. Commercial real estate, however, as measured through any number of REIT indexes, tends to offer investors a yield that is often more attractive than Treasuries, often close to a few percent more. The average spread between REIT indexes and Treasuries currently, however, is about 90 basis points.
It's getting harder to make the case that incremental investments should go into REITs at this point. Commercial real estate is already going through a pretty significant corrective process. I don't expect defaults and the like to increase, but average transaction prices will come down. Banks are doing a very good job of keeping their exposure limited, though, by requiring higher levels of equity for real estate purchases.
Q: Do you see any hope for the airlines? We have questions about both Delta Air Lines (DAL ) and American Airlines' parent, AMR (AMR ).
A:I have felt for a couple of years that this industry needs to go through a dramatic restructuring akin to the railroads in the 1970s. Some of the weaker players, like US Airways (UAIRQ ), need to be absorbed into the stronger networks and their assets rationalized. This will enable prices to become more stable and reflect the true economics of air transportation -- the ongoing multibillion-dollar losses that are generated right now.
Southwest (LUV ) and JetBlue (JBLU ) can profitably navigate this environment, and before we get this dramatic reorganization, I'm hesitant to recommend anyone. Delta's price cuts have already been matched by other carriers -- negative any advantage there. Once you compete on price, you get into that slippery slope of cutting margins, which for airlines right now is extremely dangerous.
Q: Why is Citigroup (C ) going straight up and Bank of America (BAC ) going straight down?
A:I wouldn't say either bank's performance has been extraordinary in 2004 and would offer that both have good prospects in '05. They both have a national consumer franchise -- Citicorp has been at it longer. But I think it's those franchises that will reward these banks well. Both stocks trade in a very narrow range; each is a couple of points off the year's high, and the yields in both cases are over 3%, with BAC's closer to 4%.
For Citigroup in '05, they've got to avoid any potholes and snags from previous business activities. BAC needs to rationalize its recent acquisitions and get the economies of scale from full integration, and I predict both end the year up from where they are now.
Q: Do any consumer cyclicals look good to you?
A:At this point in the economic cycle, I would say the consumer appetite for durable goods is waning, and more money will be spent on more disposable items. Hence, the emphasis on consumer nondurables. After all, despite a very mild recession a few years back, we have one of the youngest automobile fleets on the road, the housing stock has been greatly invigorated by the lower interest rates over the last few years, and the baby boomers themselves are reaching an age where homes and the like are not as important as college tuitions and thoughts of retirement.
It's true as capital spending expands, some areas such as telecom equipment will be helped. Large product purchases will support the industrial side of the economy. Rails and freight forwarders, like FedEx (FDX ) and United Parcel Service (UPS ), are interesting ways to play global trade and transactions, but they're service companies more than anything. So from that perspective there are still opportunities to be had in those categories.
Q: So in consumer nondurables can you give us any names?
A:Procter & Gamble (PG ), certainly. Johnson & Johnson (JNJ ). Among retailers, Electronics Boutique, which I mentioned earlier. Sanderson Farms as well, also mentioned earlier.
Q: What lesson would you leave for investors as we start the new year?
A:More often than not, it's time in the market, not timing the market, that makes a difference. Last year, there were negative returns for nine months, and we made all our money in the last quarter of the year. In addition, the big events heralded last year went without incident -- conventions, Olympics, elections, which made investors nervous at the time.
We're often given the opportunity to sell stocks that have valuations that are no longer sustainable, and we should not miss those opportunities. The overall environment in 2005 for equities looks very promising -- certainly stronger than in the beginning of 2004, which in turn was stronger than the beginning of 2003. If we can have another year of solid equity returns, with more modest volatility, that would certainly take confidence a long way.
Edited by Jack Dierdorff