Where "Muted Gains" Will Matter Most

Joseph Lisanti, editor of S&P's The Outlook, remains quietly upbeat, especially about certain IT, consumer, and health-care stocks

Even allowing for the slide on the Street over the past two sessions, the stock market is on its way to a strong finish for the year -- up 23% on the Standard & Poor's 500-stock index, according to the prediction of Joseph Lisanti, editor of the S&P newsletter, The Outlook. As of Sept. 23, the index is up 17% this year, he reports. However, he sees muted gains in years to come. Usually, he says, fear and greed are the major influences, but he expects those two factors to balance each other out at the same time that the effects of the current fiscal and monetary stimulus wear off.

Lisanti says S&P suggests investors overweight consumer-discretionary, health-care, and information-technology sectors in their portfolios. But he cautions that in health care the large pharmaceutical companies are less attractive than biotech, health-care facilities, and managed health care. And in tech he counsels caution on smaller names with no earnings.

These were some of the points Lisanti made in an investing chat presented Sept. 23 by BusinessWeek Online and Standard & Poor's on America Online in response to questions from the audience and BW Online's Jack Dierdorff. Edited excerpts follow. A full transcript is available from BusinessWeek Online on AOL, at keyword: BW Talk.

Note: Except where noted, Joseph Lisanti has no affiliation with any of the companies he will discuss. S&P's other affiliates may provide services to the companies under discussion.

Q: Joe, stocks today [Sept. 23] regained some of the ground they lost yesterday. Was that just a pause in a general uptrend?


We think the market in general is heading higher. We expect the S&P 500 to end the year at 1085, which would represent a 23% gain over yearend 2002.

Right now, the index is up about 17% year-to-date. We don't expect it to go straight up from here. Remember, September historically is the worst month for stocks, and October, in the past, has seen some nasty surprises. Even so, we think the trend looks good, and we are on target for the first positive year in the last four.

Q: What do you think of International Game Technology (IGT )?


S&P's analyst in the gaming industry currently has a 3-STARS [hold] ranking on IGT. Although he expects the company to benefit over time from new markets, he believes it's fairly priced at about a 25% premium p-e to the S&P 500.

Q: Any gaming stocks S&P likes better than IGT?


Among gaming stocks, our current favorite is Harrah's Entertainment (HET ). We have a generally favorable view of the news that Harrah's intends to acquire Horseshoe Gaming, which should boost the company's presence in some Southern and Midwest gaming markets. Based on our discounted cash flow and p-e analysis, we have a 12-month target price of $50.

Q: Are tech stocks bubbling again?


Good question. And the answer depends on which tech stocks we're talking about. We generally have an overweight market position in the information-technology sector, yet we would be very careful about some of the smaller tech stocks that have no earnings and no prospect for earnings over the next year or so.

Our overweight position is based on a belief that information-technology stocks will benefit from the generally improving economy. While some of the better names in the group are attractive now, including IBM (IBM ), Cisco Systems (CSCO ), and Texas Instruments (TXN ), we would generally advise people to be more cautious with smaller tech stocks.

Q: Gold stocks are at a five-year high -- will they go to a 10-year high?


While gold has already had a nice runup, rising from an average price of $309 in 2002 to more than $380 recently, our metals analyst believes that it still has further to go. He believes the price of gold should end this year somewhere between $380 and $400 an ounce, as investors continue to seek out safe havens in a troubled world.

Q: Any gold stocks on the buy list as a result?


We currently like Barrick Gold (ABX ), which we rank 4-STARS, or accumulate. It's the second-largest gold company, following its acquisition of Homestake Mining in December, 2001. We also like Newmont Mining (NEM ) -- the world's largest producer.

Q: Joe, what sector do you believe will outperform others within a year?


We're currently overweight in information technology, consumer discretionary, and health care. One caution about health care: We're least positive on the large pharmaceutical companies and feel that biotech and health-care facilities and managed health care will be among the better performers.

Q: Three companies in one question -- what's your take on Microsoft (MSFT ), Teva Pharmaceutical (TEVA ), and Textron (TXT )?


A word of disclosure first -- I own shares of Microsoft. Our analyst on the company likes the stock as a buy and has recently raised our 12-month target price to $35, from $32. Worldwide PC unit shipments have been better than expected recently and could significantly benefit Microsoft in fiscal 2004, which ends in June.

We currently have an accumulate (4-STARS ranking) on Teva. The company's earnings are being driven by 14 new generic launches and a 35% rise in sales of Copaxone for the treatment of MS, which now has 37% of that market. We currently rank Textron as a hold. Its Cessna aircraft unit has been suffering because of the weak global economy. We consider the shares fairly priced now.

Q: What's S&P's outlook for bank stocks?


Overall, we see bank-share prices as likely to perform about in line with the broader market over the next six to nine months. We also expect interest rates to rise gradually, which should make it difficult for the group to outperform on a relative basis. There are, however, some banks that we currently rank 5-STARS, including AmSouth Bancorp (ASO ), Compass Bancshares (CBSS ), and Sovereign Bancorp (SOV ).

Q: What do you think of Boston Scientific (BSX ) in the next 12 months?


Our analyst who follows medical-device makers currently ranks Boston Scientific shares at 4-STARS (accumulate). The company's recent disclosure of trial data for its Taxus drug-coated stent reinforces our opinion that Boston Scientific could capture at least 50% of the U.S. drug-coated coronary-stent market by mid-2004. The primary risk seems to us to be a potential price war with Johnson & Johnson (JNJ ).

Q: What's your take on Hewlett-Packard (HPQ )?


We currently rank Hewlett-Packard shares as 3-STARS, or hold. HPQ reported July quarter earnings of 23 cents per share, 4 cents below our estimate on revenues that also fell a little short of our model. Gross margin was 100 basis points (1 percentage point) below our estimates, and HPQ admitted it priced desktop computers too aggressively. Shares are selling close to our target price, based on our discounted cash-flow analysis. We therefore advise holding.

Q: What effect does the weakening U.S. dollar have on the market as a whole?


Although the dollar weakened significantly against the yen and was recently at a three-year low against the yen, it's not at a low against the euro. Our economists believe the dollar has been too strong for the last few years. We think an orderly decline in the dollar will ultimately be good for stocks, since it will improve earnings of companies with overseas sales or operations. In the short term, however, there may be some pain, particularly in the bond market. Nevertheless, we see an orderly decline in the dollar as a net positive.

Q: How is United Parcel Service (UPS ) ranked?


UPS currently has a 3-STARS ranking. The shares trade at a value, based on our 2004 target price, well above those of FedEx (FDX ) -- despite our view that the two stocks deserve similar valuations, due to converging business models and returns on capital.

Q: What telecom stocks are worth holding? Verizon (VZ ), SBC (SBC ), BellSouth (BLS ), and Vodafone (VOD )?


We're generally not positive on the shares of telecom-services stocks. Verizon we currently rank as 3-STARS. We give VZ a slight edge over the other Bells due to the strength of its wireless operations. In our view, growth is not on the horizon for SBC, and it has been losing local access lines. We currently rank SBC shares as 1-STARS, or sell.

Our analyst recently downgraded Vodafone shares to avoid. The increased competition we see in the U.K. and lowered forecasts for growth in some key overseas markets, in our opinion, have reduced the likelihood that this global wireless-services provider will generate above-average earnings growth.

We currently rank BellSouth as a hold, 3-STARS. We continue to see challenges for the company, particularly from wireless substitution -- meaning, customers eliminating their traditional phone lines and using just cellular service. We also see challenges from increased wireline competition. However, we believe the share price now largely reflects these issues, and we advise holding.

Q: Off to Internet shopping -- how about eBay (EBAY )?


We rank eBay shares at 3-STARS. Despite healthy growth, the shares have a huge p-e multiple, well above that of the S&P 500. We would not add to positions at this time.

Q: Will AOL Time Warner [soon to be just Time Warner] (AOL ) ever rebound?


That depends on what you mean by rebound. We expect it to go up. We currently have it ranked as 4-STARS. We have a 12-month price target of $19. This remains well below its all-time high of more than $95.

Q: Joe, what do you see as the strongest influences on the market these days?


Although earnings and the rebounding economy are major factors in the advance that we see continuing into next year, personally I think the market is driven by fear and greed. I don't think too many investors are feeling greedy these days, as many were during the dot-com era.

But I think there's less fear about investing in stocks than there was in the three down years following the bursting of the bubble. It's very likely that fear and greed will balance each other in the years to come. That, combined with an economy that may slow a bit after the current fiscal and monetary stimulus wears off next year, implies that we could have muted gains in the stock market for several years to come.

Edited by Jack Dierdorff

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