Don't Count on a September Pullback

U.S. Global Investors Bonnel Growth Fund's Arthur Bonnel says: When everyone thinks something like that will happen, it never does

The conventional wisdom is that the stock market will pull back in September. But partly because so many people are expecting that, it's not likely to happen, according to Arthur J. Bonnel, portfolio manager of the U.S. Global Investors Bonnel Growth Fund. His recommendation: "Hang in there, and expect higher prices."

As the manager of a growth fund, Bonnel believes that good earnings in the health-care sector, as well as those from a couple of retailers, point to those areas as places to look for growth. Although high valuations in the market generally are a worry, he thinks that strong earnings will reduce the valuation numbers and that a recovering economy will also help.

Among the health-care stocks Bonnel says show promise -- but not guaranteed results -- are Atrix Laboratories (ATRX ), Bentley Pharmaceuticals (BNT ), Community Health Systems (CYH ), Cybron Dental Specialties (CYD ), Genzyme (GENZ ), HCA Inc. (HCA ), Lincare Holdings (LNCR ), and Sierra Health Services (SIE ).

These comments were among many Bonnel made in an investing chat presented Aug. 21 by BusinessWeek Online on America Online, in response to questions from the audience and from Jack Dierdorff and Karyn McCormack of BW Online. Edited excerpts from this chat follow. A full transcript is available on AOL at keyword: BW Talk.

Q: Art, the market is higher than it has been in more than a year. Do you think the momentum will continue?


We're pleased that we're having upside breakouts in the market, and it's hitting higher highs and higher lows -- this is very positive. This trend should continue until we see a change in the trend. We're not saying that to be humorous, but the trend tends to continue until you have a definite change. So you continue to play this market on the long side. That, basically, would be according to Graham and Dodd.

Q: What do you think about valuations, now that some of the major indexes are at new highs for the year?


Valuations are one of our main concerns, needless to say. According to today's Wall Street Journal, the price-earnings ration (p-e) on the Dow is 21.4, on the NASDAQ it's 99.95, and on the S&P 500 it's 28. So yes, we're slightly concerned. However...we look at growth and earnings for all the companies on the New York and NASDAQ exchanges, and we were quite pleased with second-quarter earnings, and see them as a favorable prelude to the third and fourth quarters. If earnings continue to come through, this will reduce the extreme valuations that the market is selling at. We feel that the market can sustain these levels because of the strengthening of the economy.

Q: What sector of the stock market is likely to show the most growth?


A very good and provocative question. The real answer will be known only in six months to a year from now. However, earnings numbers are coming through quite strongly in health care and a couple of retailers.

Q: What are some of the stocks you like now that are reasonably priced? Can you talk about your top holdings?


What I'll do here is just name the first five or six companies in the portfolio, in alphabetical order: Alliance Data Systems (ADS ), American Standard (ASD ), Ameritrade Holding (AMTD ), AMETEK (AME ), Appleby's International (APPB ), and Atrix Laboratories.

We feel this should give you a fairly broad overview -- you'll notice how diversified the fund is. We do know from prior experience that some of these will go down, of course, because there are many matters beyond our control. Hopefully, we'll get larger gains on winners and smaller losses on losers. That's all we can hope for.

Q: Is it possible to get high yield and growth?


Generally speaking, no.... Growth-type issues generally pile back earnings into plant and equipment and research and development and pay out very low. If you're looking for income, it's the older-line companies that have reached market maturity, and their best use of the money is to reward their shareholders.... As a perfect example, you look at the growth that Microsoft (MSFT ) had in the late '80s through the end of the '90s -- it was phenomenal, and they didn't pay a cent out in dividends. Recently they have instituted a dividend. The company still has some growth potential, but look at the size of the company, and see how difficult it would be to double this growth potential. The dividend was partially instituted because of the tax-law change, but the company is definitely showing signs of maturity.

Q: Will Lucent (LU ) ever come back? Your Web site lists it as one of your fund's top holdings as of June 30.


We, of course, are hoping that Lucent does come back. We have lightened up a bit on Lucent, and it's no longer one of our top holdings, but we still hold the company, and if they can turn their fortunes around, we feel that their price could move substantially higher from these levels.

Q: Do you think we will have the historical September pullback?


Great question, and I'm glad you asked. The reason I say that is we're hearing right now that a lot of professionals and individual investors are lightening up in anticipation of a pullback. When everyone thinks something like that will happen, it never does. We right now are more on the side that the market is showing a great amount of resiliency, and the September pullback will probably not happen. If everyone was too optimistic, the odds would favor the pullback. Right now, people are more pessimistic at this juncture in time. Our opinion, however humble it may be, would be: "Hang in there, and expect higher prices."

Q: What's your view of growth stocks in general?


Our opinion of growth stocks is that every sector has its day, and you have to look at the time frame that you're in in any economic cycle. For the past three-plus years, growth has been out of favor, and the economy hasn't been growing at the prodigious gains it had during the late '90s. We've had a breather. Has it been enough? If it has, growth may just come back. We'd like to see that, but it's difficult to say if growth will be the actual leader of the pack.

Investors need to look at the macro picture. And right now, that macro picture is favoring some growth but also some of the income-type issues -- that, of course, being because of the tax package.... We feel that investors need to focus on a balanced portfolio -- some certainly in growth, but some in income.

Q: What are some of your favorite health-care stocks?


I'm not guaranteeing that all of them will go up, but what I'll do is give a few of my preferred picks in no particular order. If we hear or see anything negative, we'd immediately sell these. With that in mind, here are some that we feel might do well: Atrix Laboratories, Bentley Pharmaceuticals, Bradley Pharmaceuticals (BDY ), Community Health Systems, Genzyme, HCA Inc., Lincare Holdings, Sierra Health Services, and Cybron Dental Specialties, specifically. Again, that's a broad brush of some of the types of companies we like there at the present time.

Q: How do you feel about the food-retailing sector? And do you think that Whole Foods Market (WFMI ) is outperforming the rest?


The food sector is attractive, but as a growth-fund manager, we aren't all that optimistic on it. The industry constantly shows consistent growth -- but not the large, prodigious numbers that health care, IT, and some of the other tech-type companies might provide. Whole Food Markets has literally been in a narrow trading range since November, around the mid to low 50s.... The company will probably continue to do well, since they have good marketing and a loyal customer base. But we don't own the company and do not plan on purchasing it in the near future. We may -- in six-plus months -- if they start to show extraordinary numbers. But right now that's unlikely.

Q: Is there much growth in the electric utilities sector?


We feel that the electric utilities sector could show some respectable gains over the next year or two. This, of course, is going to be helped by Congress and the recent power outage that the East Coast experienced a week ago. These companies have been requesting federal aid to modernize their systems, and there's no doubt that legislators will be much more accommodative and sympathetic to the industry. They provide a respectable yield. As of yesterday, the Dow Jones utility average was yielding 4.2%. This makes it attractive for income-seeking investors and helps make the issues safer investments, being as you get a return.

Q: What fundamentals do you look at to pick a stock to invest in? And what's your criteria for a growth stock?


We like to look at four basic fundamentals. The first is earnings growth. We believe earnings make the market dance, and if you don't have them, the price goes down. If you don't make money, you go bankrupt. The first and foremost item is growing earnings, over the last year.... If the company shows flat earnings or a downward trend, we don't take the possible purchase another step.

The second item is the current ratio. This is basically current assets vs. current liabilities. Here, we like to see companies having a 2:1 current ratio.

The third item is the amount of debt vs. the amount of equity. A great example is the past few years. Companies that have survived have been companies with the lowest debt. We like to see less than 30% debt to equity.

The fourth item is the amount of equity ownership by management. This shows how involved management really is in promoting the growth of the company. We want them to be on the shareholder's side.... If management owns between 5% and 15%, that's positive.

Those are our four basic steps that we go through when we evaluate a company. After that, we peruse the technical patterns and make sure there's enough liquidity in the stock -- do they trade enough for us to take a meaningful position? If volume is too low, we don't take a position.

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