Economy Tech Stocks Impact Top Picks

June 4, 2002
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GRAND RAPIDS — This is the final installment of a four-part series that has followed the performance of the “Top 10 Stock Picks for 2001” as selected by six investment firms.

Here, investment advisers participating in the series discuss the performance of their group as a whole and comment on what’s ahead for the stock market and economy in 2002.

Company: Salomon Smith Barney

Investment adviser for the Business Journal series: Jon E. Lawrence

Title: First Vice President and Branch Manager, Salomon Smith Barney/Grand Rapids

2001 Top 10 Picks:

McDonald’s Corp. (NYSE: MCD)

Enron Corp. (NYSE: ENE)

Bank of New York (NYSE: BK)

John Hancock Financial Services (NYSE: JHF)

Amgen Inc. (Nasdaq: AMGN)

Tyco International Ltd. (NYSE: TYC)

AOL Time Warner (NYSE: AOL)

WorldCom Inc. (Nasdaq: WCOM)

International Business Machines Corp. (NYSE: IBM)

Nortel Networks Corp. (NYSE: NT)

“We had two in the group that absolutely crushed us,” said Lawrence of the group’s performance. The problem picks were Enron, which was down 98 percent as of Dec. 5 and subsequently filed for bankruptcy protection, and Nortel, down 73 percent by that date.

The group was down 14.75 percent while the S&P was down 10.25, the Dow Jones Average down 5.6 and the Nasdaq down 17 percent.

“It’s been an ugly year if you own just a couple of the wrong stocks,” Lawrence added. “It hasn’t been just the small name stocks that have suffered, but big, quality blue chip stocks. Enron is a classic case. On the whole, it has not been a good year.”

The terrorist attacks of Sept. 11 brought a dramatic change. From Salomon Smith Barney’s perspective, the economy is regaining its footing slowly but surely. The Dow is up 21 percent since Sept. 11, the S&P is up 20 percent, and the Nasdaq is up 33 percent.

“We’ve seen a much better response out of retail sales and October home sales. The realization now that this recession actually began back in March is probably comforting to most people because we’re probably coming closer to the end of it than to the beginning of it,” he said.

SSB has a 10 percent to 11 percent upside target on the Dow and about an 18 percent upside target for the S&P.

“The only challenge is, I think, that between now and some time during the (next) year, we’re probably going to have several setbacks. There are unknowns on the military and terrorism sides.”

As to the recovery, Lawrence thinks investors may have to take a couple of steps forward and a step back now and then.

“As much as we think we’re starting to see it, I think there are still concerns as to whether we’re getting too far ahead of ourselves right now in the market. But in general we’re pretty positive on the market.”

Company: Bank One Private Client Services

Investment adviser for the Business Journal series: Mark Michon

Title: First Vice President and Managing Director for Private Client Services/Grand Rapids

2001 Top 10 Picks:

Transmeta Corp. (Nasdaq: TMTA)

Gemstar-TV Guide (Nasdaq: GMST)

Thornburg Mortgage REIT (NYSE: TMA)

Kellwood Co. (NYSE: KWD)

Yahoo! Inc. (Nasdaq: YHOO)

Carnival Cruise (NYSE: CCL)

MedImmune Inc. (Nasdaq: MEDI)

Cendant Corp. (NYSE: CD)

G&K Services (Nasdaq: GKSRA)

SPX Industries (NYSE: SPW)

As of Dec. 4, Michon’s group was down 3.65 percent compared to the S&P, which was down nearly 16 percent. In the pool of 10 stocks, weaknesses were exacerbated and, in some cases, strengths were recognized, he said.

“We’ve had some strong winners and some strong losers as well.”

His firm agrees with the National Bureau of Economic Research’s assessment that the recession may not have occurred without the events of Sept. 11.

“We had a weak economy before that, but there were some pluses that were starting to have an impact,” Michon recalled.

And there are some risks ahead in 2002.

“We’re seeing that we have some risks; we’ve got a deteriorating manufacturing sector and rising unemployment. We’re looking at unemployment to peak at about 6.5 percent, which is a low, historically, for any recession, and it’s a rate that was once considered inflationary by the Fed. We have some falling consumer confidence, but inflation is well under control.”

The combination of the unemployment rate and the inflation rate, or the “misery index” as Michon refers to it, is at 7.8 percent. Historically, when a recession begins the misery index is in the double digits.

All the indications are for a short, shallow recession, he said. His firm is looking for recovery sometime in 2002, probably around spring. He believes the stock market is already reacting to the anticipated recovery ahead.

As anticipated, the Federal Reserve Board lowered the federal funds rate another one-quarter percent on Dec 11. Michon suggests that people who haven’t refinanced their mortgage to do it now while rates are low.

“With the federal government’s stimulus package, with inflation under control and with inventory levels very low, those in aggregate should help to pull us out of this recession pretty quickly.”

Company: National City’s Private Investment Advisors

Investment adviser for the Business Journal series: Mary Jane Matts

Title: Director of Research

2001 Top 10 Picks:

Pharmacia Corp. (NYSE: PHA)

AOL Time Warner (NYSE: AOL)

CVS Corp. (NYSE: CVS)

BP Amoco (NYSE: BP)

JP Morgan Chase & Co. (NYSE: JPM)

Tyco International Ltd. (NYSE: TYC)

Qwest Communications International (NYSE: Q)

El Paso Energy Corp. (NYSE: EPG)

International Business Machines Corp. (NYSE: IBM)

Solectron Corp. (NYSE: SLR)

On an equal-weighted basis, Matts’ group was down 23 percent as of Dec. 7, just slightly worse than the Nasdaq, which is down nearly 20 percent year to date. The worst performer in the group was in the telecom sector, Qwest, down 71 percent on Dec. 7.

As to what’s ahead, the National Bureau of Economic Research now dates the start of recession to March. Matts’ firm believes the recession will be of average length, about 11 months, meaning it will likely end in early spring.

Stock prices typically hit bottom half way through a recession so it seems reasonable to suppose that Sept. 21 was the stock market bottom, Matts said.

“If our sense of where we are in the business cycle is correct, we should be in the sweet spot of the cycle for stocks now.”

The stock market is a discounting mechanism that’s already focused 12 to 18 months out, so this is the time investors begin to position for and begin to take a more cyclical stance, she said.

“The timing is good on the one hand, but on the other hand valuation is fair to middling. Just on a raw price-earnings basis, stocks look OK because interest rates are low.”

But based on a more sophisticated scenario forecasting approach for stocks and bonds over the next five years, the return from stocks looks unappealing relative to the return from bonds. On that basis, stocks will go over valued, Matts said.

“Were it not for the renewed concern we have about valuation, we’d clearly be pretty bullish on stocks. We’re recommending a normal exposure to stocks, meaning that for an account that is normally 60 percent stocks and 40 percent bonds, we’re recommending to be at that neutral position of 60 percent stocks.

“There’s an overemphasis right now on health care, consumer staples, utilities, energy — the type of stock that does fairly well in recession. We would be starting to peel out of that and go more toward consumer cyclical, industrial cyclical and technology, more so than we are right now.”

Company: Huntington Bancshares’ Private Financial Group

Investment adviser for the Business Journal series: Randy Bateman

Title: Senior Vice President and Chief Investment Officer

2001 Top 10 Picks:

Phillips Petroleum (NYSE: P)

Anadarko Petroleum Co. (NYSE: APC)

First Data Corp. (NYSE: FDC)

Citigroup (NYSE: C)

Equity Residential Properties Trust (NYSE: EQR)

Franklin Resources Inc. (NYSE: BEN)

Kroger (NYSE: KR)

Bristol-Myers Squibb (NYSE: BMY)

Johnson & Johnson (NYSE: JNJ)

Pfizer Inc. (NYSE: PFE)

On an equal weighted basis, Bateman’s group was down 1.7 percent as of Dec. 12, while the S&P was down 13.70 percent on that date. He called the group’s -1.7 return “extraordinary” in light of the market’s volatility this year.

Bateman said going into the year he knew that 2001, like 2000, would suffer primarily from over-purchasing and the need to digest the excesses that occurred in 1999 with the buildup of Y2K. After Y2K, there was a lot of inventory that needed to be liquidated and worked off.

But his firm believes there has been adequate stimulus on both the monetary and fiscal sides and doesn’t think the recession will linger into 2002. There are signs that the economy is feeling the effects of the stimulation. Consequently, stock prices also have moved up fairly significantly in the past quarter as a reflection of that, he added.

“We’re pretty optimistic about the stock market next year,” he said. “We think the market will do fairly well primarily because of the fact that there are really no alternatives that are very attractive.”

Bond yields and money market fund yields are so low that they’re not an adequate “diversion” from the stock market once some of the fears are out of the way, Bateman said.

In every single bear market in the 1900s there were adequate alternatives; either interest rates were high, or money funds were high, or gold was attractive, or changeable assets or international markets were attractive.

“None of those situations prevail today. As long as there are no attractive alternatives to the stock market, then we have to be fairly bullish on the market. As soon as earnings start to improve, we think the stock market will be back into a bullish state.”

Company: McDonald Investments Inc.

Investment adviser for the Business Journal series: John A. Caldwell

Title: Director, McDonald’s Portfolio Strategies Group

2001 Top 10 Picks:

Cisco Systems Inc. (Nasdaq: CSCO)

Citigroup Inc. (NYSE: C)

Corning Inc. (NYSE: GLW)

Freddie Mac (NYSE: FRE)

General Electric Co. (NYSE: GE)

Medtronic Inc. (NYSE: MDT)

Pfizer Inc. (NYSE: PFE)

AOL Time Warner (NYSE: AOL)

Tyco International Ltd. (NYSE: TYC)

Viacom Inc. (NYSE: VIA)

Caldwell’s group was down 26.71 percent as of Dec. 12, versus the S&P, which was down 17.20 percent on that date.

“We under-performed the market and a lot of that was due to the continued implosion of technology stocks.” He said Cisco Systems, AOL Time Warner and Corning were the worst performing stocks in the group and really drove down overall performance.

The place not to be over the last year was definitely in technology stocks because they fell much farther than the overall market, and investors “definitely felt the pain of that,” Caldwell said.

“What we did right was make sure we had focus on quality financial stocks. Our health care stocks were bright spots because they both outperformed and we’re still big fans of health care.”

A lot has changed since January when the stock pick series kicked off.

“We were tempering our outlook in January, but the economy, even before Sept. 11, slowed farther than anybody really anticipated. We had a healthy cyclical exposure on our list and if the economy slows down, the cyclical companies are going to feel it in their fundamentals and the stock prices will move lower to reflect that.”

Caldwell said his best-case scenario is for 5 percent to 7 percent growth out of the market in 2002. There has been a bounce back in stocks since Sept. 21, the first week after the market reopened following the Sept. 11 attacks.

“The recovery since then has been much stronger than we anticipated and now we’ve got the S&P 500 up about 20 percent from those lows. With the rise in bond yields, I think the market looks pretty fairly valued. If we see the market much above 1,200 next year, we’ll come out thinking that’s a pretty good year for stocks.

“I think the one thing that folks will be focusing on — and it may be a mistake — is the unemployment rate. We know that people are losing their jobs and the unemployment rate is moving higher. As long as we stay in the 6.5 percent area, we think the economy is in pretty good shape.

“I think the biggest issue is that we’re going to see an economic recovery next year and we think the stock market is already pricing that in.”

Company: A.G. Edwards & Sons Inc.

Investment adviser for the Business Journal series: James E. Marosi

Title: Associate Vice President, Investments

2001 Top 10 Picks:

Microsoft Corp. (Nasdaq: MSFT)

Gentex Corp. (Nasdaq: GNTX)

General Electric (NYSE: GE)

Gannett Company Inc. (NYSE: GCI)

American Home Products Corp. (NYSE: AHP)

Pfizer Inc. (NYSE: PFE)

ADC Telecommunications Inc. (Nasdaq: ADCT)

Dell Computer Corp. (Nasdaq: DELL)

Nokia Corp. (NYSE: NOK)

Texas Instruments (NYSE: TXN)

In Marosi’s group there were six up and four down as of Dec. 7. Since Jan. 23, the date the first installment in this series ran, he had an average return of -8.49 percent versus the S&P of -13.97.

“In comparison to the market I think they did pretty darn good,” Marosi said. “If we had the ability to go back and pick out the two or three tech stocks that were in the portfolio, we would have looked real good. Primarily, most of those losses are attributed to one of the 10. It pulled the whole thing down.”

That’s exactly why investors must diversify their portfolios and look at different sectors in groups and markets in an attempt to beat the market, he said.

“I think this is a good example of that — that even though we had one that was down 67 percent, we were still able to outperform the S&P 500, which is always the goal.”

A.G. Edwards & Sons believes the economy is going to recover next year and strong signs of that will become evident beginning late in the second quarter. The firm likes cyclical stocks for next year because they tend to be the ones that benefit the soonest in a recovering economy.

“As for ranges for next year, we fully expect the S&P to reach somewhere in the neighborhood of 1350 by late 2002,” Marosi said. His firm’s expectations are for an approximately 15 percent growth rate in operating earnings in the S&P and an economy that still has low inflation and low interest rates.

He estimates that 12,000 is achievable for the Dow Jones Industrial Average for 2002 and 2,500 on the Nasdaq by the end of next year.

“We look for a good bounce-back recovery type of year and certainly think investors should be invested, because this is still a very good opportunity to buy a lot of high quality company stocks very cheap.”           

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