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Investor outlook 2001
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June 18, 2001: 8:10 a.m. ET
Energy, consumer cyclicals and financials should remain hot
By Staff Writer Shelly K. Schwartz
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NEW YORK (CNNfn) - If you believe what you hear on Wall Street these days, the economic storm that's been ravaging the markets since early this year is about to let up.
With lower interest rates in effect, tax refunds on the way, and consumer confidence that just won't quit, many of the nation's top equity strategists expect a return to stability in the second half of 2001.
Most also agree, however, that the economic recovery forecast for the next few months will not lift all boats.
Some sectors are poised for vigorous growth, analysts suggest, while others remain wounded on the battlefield of double digit returns. And tech stocks? Well, don't expect the few left standing to flirt with year 2000 valuation levels again anytime soon.
"In the first half of the year, investors really needed to be somewhat divorced from reality," said Eric Wiegand, an equity strategist with Credit Suisse Asset Management's private client group. "It was not dissimilar to the first half of 2000, where investors ignored valuations. Now, investors have shifted their focus towards the latter half of the year and the idea that we've paid our price; that we'll benefit from monetary and fiscal stimuli working their way into the system. And I think they're right."
Even so, Wiegand, like others in the industry, cautions the coming months may prove no less hazardous for investors.
"Security selection is going to continue be very important," he said. "With just about every industry there's been a meaningful divergence between the best performing issues and the worst."
Where, then, should investors turn while the markets find their footing?
Power plays
Sam Stovall, senior investment strategist for S&P Equity Group, said one good place to park your dollars is the energy sector, which is fast becoming a darling of Wall Street. The blackouts and soaring electricity prices in California, he notes, are indicative of the burgeoning demand for power fueled by oil, natural gas and nuclear energy.
"Our feeling is that energy stocks will be good performers," Stovall said. "While inventories seem to be in balance with demand now, we see that as being temporary, that demand will soon start to outpace supply this summer."
So far this year, the energy stocks that help make up the S&P 500 index have returned 1.8 percent. They were up 13.2 percent last year.
According to the S&P sector scorecard, oil and gas companies that focus on refining and marketing power remain the best performers within that category, surging 27.4 percent year-to-date and 26.8 percent last. The S&P 500 overall is off roughly 4.2 percent so far this year.
Among S&P Equity Group's top energy picks: BJ Services (BJS: Research, Estimates), Nabors Industries (NBR: Research, Estimates), and Patterson Energy (PTEN: Research, Estimates).
(Click here for a list of energy stocks)
Mutual funds that are weighted heavily in energy stocks are riding high as well. According to fund-tracker Morningstar, natural resource funds are up 4.2 percent through June 7, with a 1-year return of nearly 18 percent.
The top energy fund performers year-to-date have been: Ivy Global Natural Resources A with a 26.8 percent return; State St Research Global Res S, which returned 17.42 percent; and the RS Global Natural Resources fund at 17.15 percent.
(Click here to check your mutual fund)
"Natural-resources funds have been up and down thus far in 2001. In April, the category's 10 percent rise pulled the average return out of negative territory for the year," writes Morningstar analyst Dan McNeela, who notes that rising oil prices continue to bolster returns. "The White House has also contributed to the category's recent success with overtures about the need for increased exploration and production."
Interest-rate sensitives
With the central bank taking steps to ward off an economic recession, financial stocks also are landing on the top of many analysts' lists.
That's because brokerage firms and banks are most likely to benefit from lower interest rates. Since January, Federal Reserve Chairman Alan Greenspan has lowered short-term interest rates by a half percentage point on five separate occasions.
"One area where investors can be more comfortable later this year and early next are the interest-rate sensitives, like brokerages and banks," Wiegand said. "We've got lower interest rates against a gradually improving economic backdrop."
One of his top picks for the sector: Citigroup (C: Research, Estimates).
"All told, we think that this is a great franchise and its valuation continues to be very compelling for investors," Wiegand said.
Leslie Heckman, managing director of global asset allocation for Salomon Smith Barney, also favors financial stocks.
"We are still more heavily weighted toward financials, which we see benefiting from interest rate reductions," she said. "They're relatively cheap compared with other sectors, especially the banks, and their growth is a little more steady."
Year-to-date, mutual funds that invest in financial stocks have returned just 0.73 percent, but they boast a 1-year return of nearly 22 percent.
Scott Cooley, a fund analyst with Morningstar, said the flagging stock market has sapped the profits of asset managers and brokerages. But he notes that savings and loans and smaller banks have "generally prospered this year, as investors count on the Federal Reserve's interest-rate cuts to bolster their bottom lines."
His top fund picks for the sector: John Hancock Financial Industries A (FIDAX); Davis Financial A (RPFGX) and INVESCO Financial Services Inv (FSFSX).
Financials aren't the only stocks that benefit from lower interest rates, however.
Stovall said he expects basic materials companies, including Smurfit-Stone Container (SSCC: Research, Estimates), and consumer cyclicals, including Electronics Boutique (ELBO: Research, Estimates) and Barnes & Noble (BKS: Research, Estimates), to benefit immediately from the lower cost of borrowing and the economic recovery under way.
Looking ahead
Same goes for the capital goods sector, especially some of the larger conglomerates that are especially sensitive to an improving economy.
Within that sector, Wiegand said Tyco International Ltd. (TYCO: Research, Estimates) is shaping up to be a good bet for investors. With solid cash flow, the Bermuda-based maker of everything from fire alarms to syringes is trading at about 17 times the consensus estimates for 2002 and is sitting on a 20 percent projected growth rate.
At the same time, Wiegand continues to recommend large-cap health care securities.
"We still like this sector, although it could be subject to some investor selling as investors become less defensive and more aggressive," he said. "But it provides a compelling entry for investors. We would argue that big names like Pfizer (PFE: Research, Estimates) are going to be great second-half stories."
Going global
Domestic stocks alone, however, do not a portfolio make.
Heckman, of Salomon Smith Barney, said the economic upturn forecast for the latter half of this year, is likely to give other markets around the world a much-needed boost.
"What I could see happening in the next six months is that, even though right now there are relatively few leading indicators heading up in the U.S., growth rates will start to pick up, regardless of the tax cut effects," she said.
Heckman predicts the U.S. stock market will "do well" as a result and that most other markets in developed and emerging countries will immediately follow suit, with the exception for Japan which continues to suffers from deep-rooted structural problems.
She expects domestic GDP numbers to come in at around 3 percent in the second half, compared to 1 percent for the first half of the year. And she said the wise investor should have 20 percent of their portfolio outside the U.S. with the biggest portion in Western Europe. A piece of international investments, however, also should be allocated to stocks and mutual funds in developed Asian markets.
"I think this might be a relatively good time to have a small piece in the more risky emerging markets including the Latin American, Asian and Eastern Europe markets," she said.
The untouchables
For now, Stovall said he continues to steer clear of most technology stocks, although a few individual issues do remain on the recommended list by S&P Equity Group analysts. Among them are: Symantec Corp. (SYMC: Research, Estimates) and KLA-Tencor Corp. (KLAC: Research, Estimates); Adobe Systems (ADBE: Research, Estimates); Doubleclick (DCLK: Research, Estimates); and IBM (IBM: Research, Estimates).
"We are still staying away from technology," he said. "We do have a few buy recommendations which are very selective, but those we do favor in the technology sector are mainly in areas where demand is fairly static. We also think some of the semiconductor equipment companies are likely to make a turnaround earlier than other technology areas."
Many equity strategists, including Heckman and Wiegand, suggest investors maintain at least a sliver of their portfolio pie in tech stocks – saying they can't afford to shun the sector entirely. Even after the sharp selloff in the spring of 2000, tech stocks still represent roughly 20 percent of the S&P 500 index.
"We continue to be long-term believers in the productivity enhancing benefits that technology brings to corporations and consumers and we've seen a tremendous adoption of technology over the last few years," Wiegand added.
Calling the markets
As for where the major U.S. indexes are likely to end the year, the S&P Equity Group said it expects the S&P 500 index to close at roughly 1,350, with the Nasdaq composite index closing at 2,600. It does not have predictions for the Dow Jones industrial average.
Ed Kerschner, the key global strategist for UBS Warburg, offers a more lofty outlook for the S&P 500 index, predicting a close of 1,715 for 2001 and 1,835 by the end of 2002.
And as far as percentages go, Wall Street expects the S&P 500 index to finish 2001 down 4.1 percent over last year, with an 18.7 percent rise forecast for 2002, according to First Call consensus estimates.
Likewise, it notes, the Nasdaq is likely to finish down 22.2 percent this year, with an 86.9 percent surge next. And the Dow Jones industrial average is forecast to drop 7.9 percent this year, with an 18.7 percent surge in 2002. The healthy growth rates predicted for next year are due largely to weaker year-over-year comparisons, which make it easier for companies to meet or beat their quarterly earnings numbers.
(Click here to find out how the markets are performing today.)
Regardless of what happens in the markets, however, one thing is clear: Investors can no longer skate by with a cursory knowledge of market trends. They'll need to select the stocks they buy with a watchful eye on financial statements and they'll need to shed the notion that 20 percent gains are par for the course.
Just what kind of returns they can expect will be answered by the speed and duration of economy recovery.
"For the second half of the year, we think it's going to be very constructive," said Wiegand, of Credit Suisse. "You will have meaningfully easier earnings comparisons, which is powerful in and of itself. But we'll also be realizing some of the benefit of lower interest rates and tax rebates. Consumers are ultimately the real wild card. Will they continue to spend and invest even though they've seen a spat of layoff announcements?" 
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