The Dollar Is the "Wild Card"

Barry Hyman of Ehrenkrantz King Nussbaum thinks the weakening greenback will be a key element for investment strategies in 2005

With the dollar already having dropped 20% against the euro, Barry Hyman, equity market strategist for New York investment boutique Ehrenkrantz King Nussbaum, thinks it holds the key to what'll happen in the new year. Hyman sees a rise in interest rates and inflation threatening the stock market in the second half. His prediction: "The dollar is going to be the important issue as a wild card for 2005."

In this environment, he points to three sectors for potential investment: industrial cyclicals, consumer staples, and energy. He sees the weaker dollar helping exports in both of the first two areas. But he counsels diversification not just among sectors but also among small-, mid-, and large-cap stocks.

As examples of stocks his analysts like, Hyman mentions two small-cap biotech names, Discovery Laboratories (DSCO ) and Indevus Pharmaceuticals (IDEV ). In industrial cyclicals he suggests an exchange-traded fund to minimize risk, and among the consumer staples he names Coca-Cola (KO ) as a turnaround play (see BW, 12/20/04, "Gone Flat").

These were some of the points Hyman made in an investing chat presented on Dec. 9 by BusinessWeek Online on America Online, in response to questions from the audience and from Jack Dierdorff and Karyn McCormack of BW Online. Following are edited excerpts from this chat. AOL subscribers can find a full transcript at keyword: BW Talk.

Q: Barry, it's yearend forecast time -- what do you see ahead for stocks?


My forecast for the rest of 2004 is moderately higher prices. We have not changed our 2004 forecast, since the market has fallen pretty much in line, and we still see the S&P 500 (which is how we measure the market) closing around 1,200.

Our forecast for 2005 is somewhat complicated, because we expect a strong first half of the year, because of continued earnings growth and economic growth, but in the second half we expect inflation and worries about the weakening dollar to become an important story once again. So as a fair value for 2005, currently we believe an S&P 500 level of 1,300 would be appropriate. We foresee the year ending at around 1,270.

We believe the dollar is going to be the important issue as a wild card for 2005. The dollar has dropped almost 20% against the euro over the past two years.... A weaker dollar, which we do expect, is inflationary and would cause interest rates to rise more dramatically than the measured tone that Mr. Greenspan has pointed to in the last few months.

Q: Are you recommending certain stocks or sectors, given your outlook and the wild cards you just mentioned?


Yes. We have a sector view for 2005 that is similar to 2004 in terms of overweighting or underweighting sectors. Our choices for 2005 are industrial cyclicals, as they represent a play on a weaker dollar and an export market with strong trends in Asia, as well as a continued economic recovery in the U.S. Secondly, consumer staples, which were not a favorite in 2004, will in our opinion benefit from a weaker dollar, since many of these companies are huge exporters.

Even though we've seen oil prices drop down recently, we believe energy is a good sector as well. Energy remains a sector we believe can exhibit strong year-over-year earnings growth. A $40-a-barrel average price, or even somewhat lower, is still above a trailing four-year average price for that commodity. Therefore, we think there could be positive earnings surprises in this sector still, after the wonderful year it had in 2004.

Q: Are Microsoft (MSFT ) and Cisco (CSCO ) dead money?


As a sector choice, we are warming up to the technology has to be careful, in developing an investment model, to diversify well enough among large-cap, mid-cap, and small-cap opportunities. Only staying with the large-cap stocks -- with Microsoft and Cisco, which are great companies, but possibly deemed as past-markets' winners -- we believe would be a mistake that investors often make in limiting their investment choices to the most obvious large-cap stocks.

These will likely be market followers that could offer somewhat greater-than-market returns, but one should be more diversified and possibly seek a portfolio of smaller stocks as well to take advantage of new technologies. In that light, there are many technology sector funds and mutual-fund managers whose specialties are in this category and offer great diversification and opportunity that would likely outperform a Microsoft or a Cisco.

Q: Small stocks have been doing better than large caps, in general. Do you see that continuing? And can you name any that you like?


This year has been a great year, once again, for the small-cap market, and 2005 will be once again a good year for that type of investment.... As long as interest rates remain in a slow grind upward, without any dislocation of equity markets to interest rates, the sector is viable and remains a strong investment theme.

We like many biotechnology stocks covered by our analyst, where a diversified portfolio makes sense. Two names that we currently rate as "outperform" would be Discovery Laboratories and Indevus Pharmaceuticals. In the energy sector -- it's remaining a strong investment theme -- Key Energy Services (KEG ) is a good opportunity. In communications-component stocks, we have outlined Harmonic (HLIT ) as an opportunity in that sector.

Q: Your thoughts on Citigroup (C ), Bank of America (BAC ), and J.P. Morgan Chase (JPM )?


The large money-center banks, while still performing moderately well, could be expected to exhibit some concern as we get deeper into 2005. That is because of our forecast for higher interest rates.... Clearly, Bank of America has been the best-performing stock here, and we would continue to maintain positions in the sector until we get deeper into 2005.

I would be more concerned as to the size of the next interest rate hikes in the next two meetings expected by the Fed, as to whether they remain moderate and measured in their policy. Anything away from that scenario would tend to hurt the financial sector.

Q: You said you liked industrial cyclicals -- any names for us among them?


In the industrial cyclical sector, the stocks that are technically poised for further gains are companies like Caterpillar (CAT ). Where I would really focus, and where I am a strong proponent, is in the exchange-traded-fund world, where you get diversification from whoever's offering the product. I would investigate the S&P SPDRs to keep down possible stock risk. I like these because they offer the possibility to start a position in the sector, rather than an index fund, and monitor the performance in a sector with a fund rather than an individual purchase. The S&P Select Industrial (XLI ) is a good one to track that area.

Q: Back on tech -- your thoughts on Apple Computer (AAPL )?


Where was everybody when the stock was trading close to cash value when the iPod was introduced about a year and a half ago? The stock was trading in the mid-teens then.... There's no doubt the iPod and spillover to other Apple products are exciting at this point, but the stock is in a parabolic rise, and when you see that type of price action, it implies a much more evenly balanced reward than we would be willing to take at this point.

That does not mean the stock isn't going higher -- it just means it's a balance of potential profits vs. losses that are much greater than three months ago, let alone 18 months ago...our firm does have a position in Apple.

Q: What do you think about General Electric (GE )? Buy, sell, hold?


From a continued perspective of liking the industrials, this is a premier play, and we think higher prices are still to come. Promises of double-digit growth in 2005 and the stock being in the right sector give GE a positive outlook going forward. There's a lot left to be gained from the highs of 2001, when the stock was close to $60. We think GE could replace an index fund in a portfolio as a proxy for future market gains.

Q: Barry, do you look for special situations or turnaround plays? Would you consider yourself a growth or value investor?


I try not to limit myself to any discipline, only because after 25 years, I've seen too many different ways of making money, and being locked into one discipline prevents one from taking advantage of these different methods. I would say, however, that I border on value to growth at a reasonable price to use in determining market moves first, sector plays next, and individual stocks, which will ultimately be determined through a combination of simple fundamental analysis and technical analysis.

Q: Another sector you like is consumer staples -- specific stocks in that area?


We highlighted today as an opportunity Coca-Cola. They have a decent 2.5% dividend and are a potential turnaround. Years of experience have shown me that the "dogs of the Dow" theory tends to work over time -- at this point Coca-Cola would be a member of the dogs of the Dow. What has interested me, watching the stock for over two months now, is the interesting restructuring announced in another stock, Colgate-Palmolive (CL ), which rocketed that stock up this week.

Not expecting that to translate directly to Coca-Cola, it does show, however, how some of these huge mega-cap companies with a large infrastructure need to control their costs to effectuate a growth story to the bottom line, or earnings. Coca-Cola is intriguing also because it has formed a very strong base in the 38 to 40 level. Given time and patience, we believe this would be a rewarding large-cap investment.

Q: What is your outlook for the oil sector? Which stocks do you like?


My forecast for oil in 2005 is $35 to $40 a barrel. Based on that, the inflationary concern of higher oil prices will be diminished, which we think filters back into a positive outlook for equities in general. A few ideas in the oil sector, where we concentrate mostly on oil-service stocks, would be some large-cap names like Ensco International (ESV ) and Schlumberger (SLB ).

In an earlier question, the transcript would show some smaller-cap names in the sector that we like as well. One caveat, though, is our current near-term forecast is that many of these stocks are fully priced, and we would be much more aggressive on expected pullbacks in the sector that we expect into the first quarter of 2005. Both the stocks I just mentioned, by the way, are rated "outperform" by our firm.

Q: What do you think is the best investment in the defense and security sector?


I'll answer that by referring back to the biotech sector, where we have one stock that does carry some risk. That stock is VaxGen (VXGN ), which is a company in biodefense, recently having won a major contract from the Homeland Security Dept. They're in the business of providing the government with potential anthrax vaccines, which over time could bring in almost a billion dollars in revenue, and the company can use that revenue stream as a platform for future growth.

The risk we outline is the fact that the company is listed on the pink sheets because of a late filing of their revised annual reports for the last couple of years. We believe that the company is making progress toward being relisted in the future, but we cannot say that for certain. Therefore, the risk warning. Our target is $26 a share.

Edited by Jack Dierdorff

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