S&P's Top Picks for 2001

Only a few tech stocks get the nod from Research Director Ken Shea, who looks for the overall market to pick up in the second half of the year

A slowdown for the economy, but no recession. A stock market that starts slow but gets better as corporate earnings improve -- and as the Federal Reserve continues to ease interest rates and a tax cut looms.

That's the forecast for 2001 from Kenneth A. Shea, vice-president and director of Standard & Poor's Equity Research & Services. In specific stock sectors, he says, S&P recommends going light on technology. Interestingly, among his top five picks for the new year is Philip Morris, which he expects to benefit from a better regulatory climate. He also points to S&P's PowerPicks Portfolio for 2001, consisting of the "best idea" from each of the 33 S&P analysts. That same concept produced a portfolio that dropped only 3% in 2000, vs. 10% for the S&P 500.

Shea spoke in a chat Jan. 9 presented by BusinessWeek Online and Standard & Poor's on America Online. He was responding to questions from the audience and from Jack Dierdorff of BW Online, the moderator. Edited excerpts from the chat follow. A complete transcript of this chat is available from BW Online on AOL, keyword: BW Talk.

Q: It was sort of a good news [for the Nasdaq and S&P] and bad news [for the Dow] day. What do you make of the market as we start the year?


S&P anticipates a slow start to the market averages the first half this year but a better second half. During the first half, S&P analysts anticipate a modest decline in operating earnings vs. the first half of last year. For the second half, we see a gain of approximately 9% in operating earnings vs. a year ago. Thus, thanks to improving earnings gains, combined with a more [accommodating] Fed policy and growing anticipation of some kind of tax cut, we see market sentiment improving markedly in the second half of the year. The S&P 500 should close the year at 1500 and the Nasdaq at 3300.

Q: How do you look at tech stocks?


S&P has an underweighting recommendation on tech stocks, owing to tough earnings comparisons in the first half of 2001 and still-lofty valuation levels in selective areas. The areas in tech that we're especially positive on, though, include computer networking, communications equipment, contract manufacturing, storage, and selected software.

Q: Any names to mention in those areas of tech?


Yes. Within those industries that I mentioned, some of the names we recommend now are Cisco Systems (CSCO ), Sun Microsystems (SUNW ), JDS Uniphase (JDSU ), Nortel Networks (NT ), Sanmina (SANM ), Solectron (SLR ), Adobe Systems (ADBE ), and RSA Security (RSAS ).

Q: What are your top five picks for this year?


No. 1 is BJ Services (BJS ), a leading international oil-drilling service company that's benefiting from significantly higher activity in the search for oil and natural gas. No. 2: JDS Uniphase, the leading maker of optical telecommunications equipment products. Philip Morris (MO ) is No. 3. This company is benefiting from a significantly improving regulatory environment, a very low p-e ratio, and a generous 5% dividend yield.

Another is Allstate (ALL ), a leading property/liability insurance company. That company is benefiting from improving pricing. And finally, Tenet Healthcare (THC ), the second-largest U.S. acute-care hospital operator. They're benefiting from favorable Medicare and private-pay pricing trends.

Q: What is your projection on the economy for 2001?


S&P anticipates an approximate 3% gain in real gross domestic product -- a respectable showing, but also a material slowdown from last year's extraordinarily high 5%-plus rate of growth. S&P believes that the Fed's increasingly accommodating stance will enable the economy to avoid a recession this year.

Q: What do you think of [real estate investment trusts]? Any specific REIT stocks to cite?


We're cautiously optimistic on REITs for a number of reasons. First...rents should remain relatively high. In many sectors, old leases are also rolling over at higher current rates, which should be a plus for funds from operations. One of the stocks that we like is Equity Residential (EQR ), an apartment REIT. Boston Properties (BXP ) and Spieker Properties (SPK ) are both office REITs.

Q: One-year outlook on WCOM (WorldCom)?


S&P recommends accumulating WCOM shares in light of the company's diverse asset base and leading position in various communications markets.

Q: How do you like the biotech sector for 2001? Your opinion on Genentech (DNA , Amgen (AMGN ), and Pfizer (PFE )?


We're cautiously optimistic on biotech. Positive developments such as important Food and Drug Administration approvals, progress in expanding market share of established drugs, and growing pipelines across the industry are somewhat tempered by high valuations relative to other industries. Although this industry is inherently volatile, we believe that there remain selected attractive opportunities -- for example, Cephalon (CEPH ), COR Therapeutics (CORR ), and IDEC Pharmaceuticals (IDPH ).

The more mature pharmaceutical companies, such as Pfizer (PFZ ), King Pharmaceuticals (KG ), and Schering-Plough (SGP ), are excellent long-term-growth opportunities. Some faster-growing biotech-related companies, such as Genentech and Amgen, are also good long-term names, though we have hold ratings on both right now because their valuations are quite high.

Q: Do you like Williams Companies (WMB )?


Yes. S&P reiterated its buy recommendation on WMB today, despite the news that the company plans to sell 30 million new common shares in the market. This represents less than 7% earnings dilution, and our year 2000 EPS estimate remains at $1.35. WMB is poised to gain from continued strong natural-gas industry fundamentals and remains very attractive at current levels.

Q: What do you think is going to happen with Intel (INTC )?


S&P analyst Megan Graham-Hackett recommends accumulating Intel in light of the company's dominant position in the semiconductor industry, with innovation being a key company strength.

Q: Do you like CVS? Add if you will any thoughts on other retailers.


S&P analyst Maureen Carini recommends CVS as a buy, in light of the company's dominant position in pharmacy sales, store count, and same-store sales growth.... S&P is generally cautious on other retailers, however, in light of weaker-than-expected December sales.... Over the longer term, we still expect discounters to gain market share from the department stores.

Q: Oil services -- what's your outlook? Any special players? You mentioned BJ Services.


S&P is positive on the oil and gas companies, particularly those companies involved in exploring for natural gas and oil. Our favorites include: BJ Services, Evergreen Resources (EVG ), Patterson Energy (PTEN ), and UTI Energy (UTI ).

Q: AOL and Global Crossing (GX ) -- buy or sell?


S&P analyst Scott Kessler, another guest on these chats, recommends holding AOL. That's largely related to uncertainty surrounding advertising and the company's valuation. S&P recommends accumulating Global Crossing, as the company's growth prospects look quite positive.

Q: What's your current opinion on Motorola (MOT ) and Nortel (NT )? You listed NT earlier.


We recommend avoiding Motorola. We recently reduced its sales and profitablility outlook. We continue to recommend purchasing Nortel. We believe it will drive 40%-plus earnings per share growth annually over the next few years. We thus believe that this market leader is attractive at a valuation that seems reasonable.

Q: Opinion on long-term holding of FleetBoston Financial (FBF )?


We recommend buying FBF. That's because the company's dynamic product mix and the value of several dynamic underlying businesses are not being fully reflected in the stock's valuation.

Q: Ken, S&P has a PowerPicks Portfolio for 2001. Can you tell us a bit about it?


The S&P PowerPicks Portfolio is essentially a portfolio comprised of the single best stock idea from each of S&P's 33 industry analysts.

Q: Have you had a chance to see how the 2000 PowerPicks did in relation to the market?


We did. The PowerPicks Portfolio 2000 was down 3%, which outperformed the S&P 500's 10% drop during the year. Since its inception on Jan. 1, 1997, the S&P's PowerPicks Portfolio's cumulative total return performance through Dec. 31, 2000, was up 118.5%, vs. a 88.7% gain for the S&P 500 index.

Edited by Jack Dierdorff

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