It's a tug of war in the stock market now, with the indexes up one day, down the next, says Kenneth Shea, managing director of Standard & Poor's Equity Research Services. Good earnings reports brighten the bulls, but the bears worry about rising interest rates, he explains. "Market historians know that during periods of Fed tightening, the equity markets normally don't perform well."
Despite the volatility, he says, S&P expects its 500 index to rise in the high single digits this year. And S&P still sees a number of strong buys among stocks -- in energy, for example, Exxon Mobil (XOM ), Valero Energy (VLO ), ConocoPhillips (COP ), and Total (TOT ).
But there's pessimism about the two biggest U.S. auto makers, Shea reports, with Ford (F ) and General Motors (GM ) ranked as sells.
These were a few of the points Shea made in an investing chat presented on Apr. 26 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from Jack Dierdorff of BW Online. Following are edited excerpts from this chat. AOL subscribers can find a complete transcript at keyword: BW Talk.
(Kenneth Shea is an S&P Equity Research analyst. He has no ownership interest in or affiliation with any of the companies under discussion in this chat. All of the views expressed in this chat accurately reflect the analysts' personal views regarding any and all of the subject securities or issuers. No part of the analysts' compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this chat. For required disclosure information and price charts for all S&P STARS-ranked companies, go to spsecurities.com and click on "Investment Research" and then on "Required Disclosures & Standard & Poor's STARS vs. Closing Prices Charts.")
Q: Ken, the market keeps going up, then down, then up and down again. Can you make any sense out of this for us?
A:That's a big question. I would say that the first-quarter earnings reports, although coming in in line with most expectations, have not squelched the volatility that the market has experienced over the last few months. This is likely due to a combination of factors, but probably none more important than the Fed's stated goal of raising the level of interest rates to be less accommodative and assume more of a neutral stance.
Market historians know that during periods of Fed tightening, the equity markets normally do not perform well, so the proverbial tug-of-war continues between the bulls, excited about good earnings reports, and the bears' concerns about rising interest rates.
The Standard & Poor's investment policy committee continues to assume a constructive view of the equity markets and believes the S&P 500 will grow at a high-single-digit rate over the coming 12 months. It also recommends a model asset allocation of 40% U.S. stocks within the overall asset allocation.
Q: How big a factor do you think oil prices are now? Do they affect S&P recommendations on energy stocks?
A:S&P continues to market-weight its recommendation on energy stocks, as continued strong fundamentals are being offset a bit by lofty valuations in key areas. S&P expects oil companies to report another robust quarter of earnings for the first quarter, reflecting strong refining margins and heavy crude price discounts. In addition, natural gas prices are likely to stay at relatively elevated levels.
All this points to is continued near-term strength in the integrated oil and gas industry, as well as the refining and marketing industry. S&P recommends the purchase of stocks such as Exxon Mobil, Valero Energy, ConocoPhillips, and Total -- all strong buys.
Q: The U.S. car industry is going down. How long is it going to be like this? Your view on Ford, General Motors, and DaimlerChrysler (DCX )?
A:S&P's investment outlook on the automobile manufacturers continues to be negative. Competition is expected to remain intense, reflecting the costs of new product introductions and incentives. We remain concerned that high inventories may lead to additional production cuts beyond recent announcements, and this will further pressure industry profits. S&P continues to recommend that investors sell shares of Ford and GM and hold the shares of DCX.
Q: Qwest is vying to take over MCI (MCIP ). I own Qwest (Q ) -- hold or sell?
A:S&P recommends investors sell their shares of Qwest. S&P sees the company as likely losing in the battle for MCI, and we see the shares further restricted by the company's relatively weak margins and already high debt load. S&P believes there are many better alternative investments in the telecommunications sector than Qwest.
Q: What about Qwest's rival for MCI -- Verizon Communications (VZ )?
A:S&P recommends investors buy the shares of Verizon, as we believe it will ultimately win the bidding war for MCI. Despite the likely additional cost for the asset, we believe the company is taking the appropriate steps to grow in multiple ways, such as with wireless broadband, long distance, and its fiber build-out. We believe the company's wireless unit will continue to gain market share due to its superior network quality and data services. Its financial strength and secure 4%-plus dividend yield make the shares attractive.
Q: What's your opinion of Google (GOOG )?
A:S&P recommends investors buy Google. The company's earnings results of last week were very impressive. Revenues rose more than 90%, and profit margins expanded notably on greater scale and operating efficiencies. S&P raised its 2005 operating earnings per share forecast to $4.75, from $4.15, on projected margin expansion and raised the 12-month target price to $300, from $260.
Q: How about chip stocks? Buy, sell, or hold Intel (INTC )? And do you think Advanced Micro Device (AMD ) is a real threat to Intel?
A:S&P recommends investors hold the shares of Intel. S&P believes Intel's scale-based strengths in R&D, manufacturing, and marketing should help it prosper in a semiconductor industry expansion that we expect to last throughout this year. Although the shares are trading below historical norms on the basis of p-e, we believe a discount valuation is warranted, given what we see as above-average near-term macroeconomic risks and our expectation of a moderation in industry growth beyond 2005.
S&P also believes most chip stocks are fairly valued on this basis as well. S&P also has a hold recommendation on Advanced Micro Devices, as we expect profitability to be restricted in the short term by severe price competition in the flash memory market. The competitive battle between Intel and AMD is expected to remain intense, and that could place continued pressure on pricing.
Q: What sectors does S&P like now?
A:S&P Equity Research analysts continue to emphasize the health-care and industrial sectors. Within health care, S&P would emphasize the nonpharmaceutical areas, such as managed-care facilities, services, and medical equipment.
The pharmaceutical group, which represents nearly half of the sector's market weighting within the S&P 500, will, however, face difficult operating conditions this year, pressured by ongoing emergence of generic drug threats, rising litigation risks, and increased scrutiny in the FDA approval process. Some of the health-care stocks that S&P favors as strong buys include Covance (CVD ), Genentech (DNA ), Pacificare Health Systems (PHS ), and St. Jude Medical (STJ ).
S&P also recommends an overemphasis on industrials, reflecting our belief that the U.S. economy will experience good growth through 2008, and thus we think that this sector will see an extended cycle. Industries such as air freight and logistics, building products, and trucking should benefit. Selected industrial stocks S&P favors as strong buys include CNF (CNF ), W.W. Grainger (GWW ), Landstar System (LSTR ), Ingersoll-Rand (IR ), and Watts Water Technologies (WTS ).
Q: Back on tech, shall I buy more EMC (EMC ) at this time?
A:S&P continues to recommend EMC as a strong buy. We believe EMC will continue to benefit from a more favorable information technology spending environment, given its industry-leading position in the enterprise data storage sector. We also think the expansion of its product portfolio resulting from recent acquisition activity should have a positive impact. The company's balance sheet is sound, and its earnings report of last week was stronger than we had expected. The shares remain very attractive to purchase.
Q: Two different giants here -- any thoughts on General Electric (GE ) and Citigroup (C )?
A:S&P recommends investors hold the shares of General Electric. Strong trends for the majority of its industrial and financial segments are mitigated somewhat by its challenge to grow, given its large asset base and a full valuation. A secure and rising 2.5% dividend yield, however, offers good total return prospects at current levels.
S&P recommends Citi as a strong buy. This is based on the company's geographic and product diversity, improving earnings quality, and above-peer average revenue growth and profitability prospects that we believe are not reflected in the stock's current valuation.
Q: What is your outlook for International Paper (IP )?
A:S&P recommends investors buy the shares of International Paper, as we see business trends improving in the company's packaging and uncoated paper grades. The company's earnings report this week was solid, boosted by price increases. Although margins could be pressured ahead, the stock's valuation appears to be attractive, based on relative peer p-e analysis.
Q: Based on what sort of information does S&P make its recommendations?
A:S&P equity analysts are fundamental analysts, who incorporate a number of economic and company-specific variables into its projections for profits. Share valuations are assessed by a combination of intrinsic-relative and private-market valuation metrics.