Counting on a Little Momentum

S&P's Joseph Lisanti sees the market posting some modest gains by yearend, with Citigroup, Total, and Genentech among the leaders

What's Standard & Poor's current prognosis for the stock market in the rest of 2005? "Slightly optimistic," says Joseph Lisanti, editor of S&P's newsletter, The Outlook. So far this year, the S&P 500 index has been down, Lisanti notes, and he cites the historical precedent that in 13 of the 20 years since World War II when the market was negative at the end of May, it finished the year down.

However, he says S&P sees the index up 4% from the June 7 level of 1197 by yearend, basically because "fundamentally, the economy remains strong." He also points to the fact that the nonfinancial companies in the S&P 500 hold an all-time-high amount of cash, which they're likely to spend on mergers and acquisitions and on stock buybacks or dividends -- all of which could stimulate the market.

Lisanti says S&P currently recommends that investors overweight only three stock sectors: consumer staples, health care, and utilities. And although S&P has trimmed its forecast for economic growth in Europe and suggests a slight de-emphasis of European stocks, it still recommends that an investment portfolio be 20% in non-U.S. equities.

These were some of the points Lisanti made in an investing chat presented June 7 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts follow. AOL subscribers can find a full transcript at aol.businessweek.com/chat

Note: Joseph Lisanti has no ownership interest in or affiliation with any of the companies under discussion in this chat, except as noted.

Q: Joe, does S&P see any chance the stock market will regain momentum?

A:

It has been a difficult year. For the first five months of the year, the S&P 500 is down. And historically, that isn't a great sign. Since the end of World War II through the end of last year, the S&P has been in negative territory at the end of May 20 times. Thirteen of those years, it finished down for the full year. That's 65% of the time. Despite the historical precedent, we're slightly optimistic and still have a yearend target of 1245, or roughly 4% up from today's close.

Q: How about three long-term buys? I know S&P has many more than that!

A:

We do like stocks for the long term, particularly those companies that have a history of increasing their dividends. Three that are particularly good and top-quality are Automatic Data Processing (ADP ), Citigroup (C ), and William Wrigley Jr. (WWY ).

Each of these stocks is currently ranked 5-STARS [strong buy] for expected superior performance over the coming 12 months and has an S&P quality ranking of A+, indicating a superior long-term history of earnings and dividend growth and stability. We think these are attractive stocks for long-term investors.

Q: Do you think the play in oil is about over? Any energy stocks that look good?

A:

We aren't in the camp that believes in $100-per-barrel oil this year, or at any point in the near future. Our projection is that oil will average about $50 a barrel for 2005. Consequently, we aren't recommending an overweight position in energy stocks at this point.

Nevertheless, there are some attractive plays in the industry. Among the integrated oil and gas companies, our top picks include ConocoPhillips (COP ), Exxon Mobil (XOM ), and Total, the European oil giant (TOT ), each of which we rank 5-STARS. We like certain drillers, including GlobalSantaFe (GSF ). We also like Valero Energy (VLO ), which, like the others, is ranked 5-STARS.

Q: What stock sectors does S&P see as worth overweighting in this market?

A:

Right now, we only have overweight recommendations on consumer staples, health care, and utilities. We should note, however, that the overweight recommendation on health care doesn't extend to the largest component of that sector, large pharmaceutical stocks. We continue to believe that Big Pharma stocks will be pressured by patent expirations and intense competition.

Q: How about smaller plays in oil, such as XTO Energy (XTO )?

A:

XTO Energy is currently ranked 5-STARS or strong buy. Even though the first-quarter earnings report for XTO was below our estimate because of higher operating expenses, we remain bullish on the shares. We believe most of the earnings shortfall was the result of one-time items. We believe recently announced acquisitions will serve the company well in the coming year. With the stock currently about $31, we have a 12-month target price of $40.

Q: Do you think Genentech (DNA ) still has an upside? And how about biotech generally?

A:

Genentech is our top pick in the biotech area, with a current ranking of 5-STARS. We have a target price of $93, and the stock is currently a bit below $80. Among smaller biotechs, we like Amylin Pharmaceuticals (AMLN ) and Invitrogen (IVGN ), both of which are ranked 5-STARS. Overall, however, we're fairly neutral on the biotech industry.

Q: S&P likes consumer staples as a sector -- what about Wal-Mart (WMT ) as a buy here?

A:

First a disclosure -- I own shares of Wal-Mart. Our analyst currently ranks the stock 5-STARS, or strong buy. For the April quarter, Wal-Mart's operating earnings of 55 cents a share were 1 cent below our expectations. Margins narrowed more than we had expected, as higher gasoline prices negatively affected sales.

However, we see improvement in the second half of fiscal 2006, which ends in January, as comparisons ease. Our current target price is $59, and the shares are a bit below $48 now.

Q: Your thoughts on Citrix Systems (CTXS )?

A:

We have a 5-STARS ranking on Citrix Systems. The company recently announced a proposed purchase of NetScaler, a provider of application networking offerings, in a deal valued at $300 million in cash and stock.

We believe NetScaler would contribute notable strategic value in terms of technology, products, and customers. Although the price of 8 times sales initially seemed high to us, we now believe Citrix is paying a reasonable price based on recent peer valuations.

Q: How would you rank PepsiCo (PEP ) these days?

A:

PEP seems to be doing everything right these days. We currently rank it 5-STARS (strong buy). Worldwide volume growth in the most recent quarter was slightly better than we expected. The company has superb brand momentum and an impressive product innovation pipeline and strong cash flow. With the stock currently about $56 a share, we have a 12-month target price of $65.

Q: How does S&P explain the market's being down so far this year -- and justify the forecast of a 4% rise by yearend? (By the way, was that 4% up from the present level or from the start of the year?)

A:

It would be 4% up from the present level of 1197 and 2.7% from yearend 2004. We're a bit surprised that the market has been weak so far, but would note that May was the best month of the year for stocks. The S&P 500 gained 3% last month. While we don't expect a 3% gain every month, we don't think a 4% rise over the remainder of the year is extraordinary or out of the question.

Fundamentally, the economy remains strong. Despite efforts by the Federal Reserve to tighten, long-term interest rates remain very low. Corporate profits continue to hit new highs, even though the rate of growth is slowing a bit. And companies are flush with cash. We estimate that the nonfinancial companies in the S&P 500 now hold $631.5 billion on their balance sheets. That's a new all-time high for cash on the balance sheets of these companies. We expect it will be used for mergers and acquisitions, which should help support stock prices, as well as for share buybacks and increased dividends.

Q: S&P likes health care as a sector but not Big Pharma -- so what stocks do you like in health care?

A:

We already mentioned some biotechs that we like. Among the health care equipment makers, we have several stocks that we currently favor. Those include St. Jude Medical (STJ ), which makes medical devices for cardiovascular diseases. We currently rank St. Jude 5-STARS. We also like C.R. Bard (BCR ), a maker of a diverse line of medial/surgical-diagnostic and patient-care equipment. BCR is ranked buy (4-STARS).

We're favorably impressed by improvement in the hospital industry. Among the hospital-management companies that we currently rank 5-STARS (strong buy) are Community Health Systems (CYH ), which specializes in rural hospitals. HCA (HCA ), a major hospital-management chain, is another, along with Triad Hospitals (TRI ), which operates hospitals and ambulatory-surgery centers in the South, Midwest, and West. Again, those are all ranked 5-STARS. We also like companies in the managed-care field, including Aetna (AET ) and WellPoint (WLP ), both of which are ranked 5-STARS.

Q: What's the prognosis for Microsoft (MSFT )? Do you expect upward movement? Is it a hold or sell?

A:

Another disclosure -- I own shares of Microsoft. The stock has been in a trading range for quite a while, but our analyst ranks it 5-STARS (strong buy). We expect that its new Xbox 360 gaming console will be a positive for Microsoft, as it continues to diversify away from the PC. We also believe the company is well on its way to resolving all of its legal and regulatory problems. For those reasons, we believe that patience will be rewarded.

Q: S&P also likes the hardly glamorous utilities -- basically for the dividends? Any names there?

A:

Utilities usually pay higher dividends than other stocks. We do have several companies that we like on a total return basis, including Ameren (AEE ), which is ranked 4-STARS and has a 4.7% yield; Cinergy (CIN ), with a 4.6% yield; and Duke Energy (DUK ) with a 3.9% yield. Duke is ranked 5-STARS, the other two are ranked 4-STARS. Among water utilities, we like Aqua America (WTR ), which is ranked 4-STARS and has a 1.8% yield.

Q: How about stocks you like among consumer staples? You mentioned Wal-Mart.

A:

In the consumer-staples area, we like two of the major drugstore chains, CVS (CVS ), ranked 5-STARS, and Walgreen (WAG ), ranked 4-STARS.

In the personal-products area, our favorite is Chattem (CHTT ), a maker of a large number of branded, over-the-counter health-care products, toiletries, and dietary supplements, which we rank 5-STARS.

We already mentioned PepsiCo in the soft-drink area and Wrigley in the packaged-foods industry. In the household-products industry, our favorites include well-known names Colgate-Palmolive (CL ) and Procter & Gamble (PG ), both of which are ranked 5-STARS.

Q: What's S&P's view of the current potential for foreign markets and foreign stocks?

A:

We recently lowered our expectations for Europe. We had thought the Continent would see a 2% gain in gross domestic product for 2005, but the capital spending picture in Europe remains uncertain, and we see the possibilities of more profit warnings from euro-zone companies in the second half.

Consequently, we have trimmed our growth estimate to 1.3% and suggest a slight deemphasis of European stocks. That said, we still recommend 20% of assets be held in non-U.S. equities.

Q: And what about Asia? Where the hot growth is.

A:

We do like Canon (CAJ ), a major maker of copy machines and computer peripherals. It trades in the U.S. as an ADR [American Depositary Receipt]. Another pick from Asia is Wipro Limited (WIT ), which provides information-technology services in India, as well as R&D services to companies worldwide. Our current ranking on Wipro's American depositary receipts is 4-STARS.

For investors who don't want to deal with picking individual stocks in the foreign sector, we suggest exchange-traded funds, such as iShares MSCI-EAFE (EFA ), which encompasses the world market outside the U.S.

Q: So S&P suggests 20% of assets in non-U.S. stocks -- what's the rest of the allocation formula now?

A:

Right now, we have 40% in U.S. stocks, the 20% you mentioned in foreign stocks, 25% in bonds -- but we would limit those to short- or intermediate-term bonds only -- and 15% in cash.

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