If you're not investing in the stock market now, you should be. That's according to five experts I interviewed recently:
- David Kelly, chief market strategist at JPMorgan Funds
- John Linehan, co-director of T. Rowe Price's U.S. equity division and portfolio manager of the T. Rowe Price Value Fund
- Uri Landesman, head of global growth at ING Investment Management
- Bernie Schaeffer, chairman and CEO of Schaeffer Investment Research
- Bob Doll, vice chairman and global chief investment officer of equities at BlackRock.
In a series of questions, I asked them which sectors and regions they recommend investing in. Finally, I asked them to name names on specific companies. Here is an edited transcript of what they had to say.
What are your favorite sectors now?
David Kelly: I think the cleanest play on a global economic rebound is technology. The U.S. is an exporter of technology, and if the world economy picks up, U.S. technology firms should be big beneficiaries. We also know that technology spending has actually been rather weak within the U.S. in recent years, and this should pick up in an economic rebound.
On health care, I'm nervous because of health-care reform. The fact is, we have seen U.S. health-care spending rise so fast that any reform plan will be focused on slowing the pace of spending, which can affect the pharmaceutical companies, insurance companies, and hospitals. So that's a more complicated story.
Energy. If anything, I would be a little underweight [on] energy because energy prices are pretty high, and there's a lot of speculation there. For the next two years, I think that energy prices, based on the fundamentals, shouldn't be going up from here.
I'd also be a little positive on consumer cyclicals, as they may bounce back stronger than people think.
John Linehan: Technology still appeals to us even though it's had a nice move this year. These are companies where valuations are still reasonable. If you look at normalized earnings streams, they look cheap relative to that stream. There's not a great deal of balance sheet risk associated with the investment. Also, you're starting to see some recovery in the earnings of a lot of those companies.
Currently I think there's a significant rotation that's taking place. I think things that looked very favorable earlier in the year, things that had a lot of consumer exposure, have run fairly hard. However, I do think some names in consumer discretionary, media, or retail still have some intrigue.
Some of the larger companies with more stable cash flows are starting to look attractive as well, whether it's consumer products, or some of the large health-care providers. The dividend yield and valuation looks intriguing.
[...] On health care, the regulatory wild card is a very important one for this sector. I think, at the moment, you see insurance companies really talk to that. It's a very interesting sector in that valuations are as cheap as they've been for quite some time in a number of the larger health-care companies. But the longer-term landscape is probably cloudier today than it has been in terms of government intervention, competition, and patent expiration -- the inability of the large pharma companies to deliver new products.
There's also the fact that you're seeing significant health-care inflation costs cause inflation over a number of years, and at some point, that's unsustainable if we're going to have economic growth. So it's a real push-pull.
We're attracted to the valuations on these companies, but it's "caveat emptor" in that the fundamentals would suggest that valuations seem to be lower than they were historically.
We're in the mindset of buying the dips on energy. It's been a volatile sector. Longer term, it's fairly clear to us that the world is going to be drilling for more oil than natural gas. As such, we like the service companies. The real question is: Can the E&P companies make money at current prices? Is the return on investment adequate at $60/$70 oil? I think that still remains to be seen.
It's really more of a stock pickers' market right now, rather than a top-down sectors' market. I think when we look at different sectors, we don't see huge sectors that stand out, rather we see individual stocks within sectors that look very intriguing.
Uri Landesman: If the market goes up, and if the consensus clearly becomes that the globe has emerged from its recession, then I have very little doubt that energy and materials are going to be the two best sectors. Then industrials and consumer discretionary will follow.
The non-intuitive bet I'm making now is that health-care stocks look pretty attractive. Now, that's partly driven by the belief that Obama health-care reform will be less than what people feared. So, if they get a lot of what they wanted to pass, then I don't think health care is going to be a great place to be. I'm betting on the opposite.
Health-care stocks are at very attractive valuations right now. I know health care is going to outperform dramatically if the market corrects, and I think it can perform with the market if the market goes up. So that's a pretty attractive risk-reward for me. We're big buyers of health care.
Bernie Schaeffer: We favor the perceived "speculative" names over the "high-quality, blue-chip" themes. Wall Street has been preaching for "high-quality, blue-chip" stocks for months, and it is these names that have been left in the dust. Financials, retail, leisure, and small- and mid-cap technology stocks are among our favorite sectors.
Another area of the market that has been despised, but has shown strong price action, is U.S. Treasuries. This area of the market is not crowded due to inflationary and future supply concerns. Rather, the behavior of these assets are running counter to the widespread concerns, which we think spells opportunity and may provide a nice hedge to your long equity exposure.
China and emerging markets seem to be the favorite hunting grounds of hedge funds, which are still huge market players, despite a decrease in the industry's asset base in 2008. Whether it is China, oil, gold, or other commodities, these sectors are highly correlated with each other and are "crowded trades."
The fact that they are so crowded and so correlated suggests that one should be especially cautious when investing in these groups. This isn't to say that there isn't money to be made from the long side, but we would advise hedging your long exposure.
Bob Doll: Given that markets are up a bunch, that the economy is in the process of bottoming, and we've had this big run of cyclical, low-quality [stocks], I think you need a diversified portfolio. So, via a portfolio context, I think you need some cyclicals. My favorite sector there is energy. I think you need some defense -- my favorite sector there is health care. I also think you need some growth in the portfolio, and my favorite sector there is technology.
[...] Health-care reform is a gray, but not a black cloud for the industry, and I think the market was expecting a black cloud. Therein lies the opportunity. Part of the reason we're attracted to health care is that it has underperformed because of the concerns about health-care legislation. I think that gives people the opportunity to own these stocks with a reasonable risk-reward.
[...] There's a bit of [sector rotation]. Right now there is not evidence of consistent leadership, per se, and until we're able to identify that better, it's another reason to think the market isn't going to go straight up.
What do you think about financials?
Kelly: The financial services sector is a complicated story because of politics. I'd want to be a little overweight [on] financials because I think if the government is going to get out of the business of running financial companies, they need those companies to be profitable.
On the other hand, we do have a lot of potential losses in commercial real estate. We're seeing higher FDIC premiums, and there are plenty of other complications.
Linehan: I think the worst is behind us in financials. In the intermediate term, they look very intriguing. I think the real question is, longer term, there are still secular headwinds that face the sector. What has really driven a lot of the performance of financials over the last 25 years was deregulation, consolidation, and an interest rate environment that was very benign.
Now what you're seeing is reregulation. Rather than constructive consolidation, you're seeing more forced consolidation, and you're seeing an interest rate environment where rates have stopped going down and, at some point, will probably increase.
Longer term, that's not advantageous to financials. In the intermediate term, a lot of these stocks look relatively cheap in comparison to some sense of normalized earnings. There are a number of financials that we like, and we're torn between what would be the intermediate prospects and the longer-term prospects.
Landesman: Financials are tough to call. I don't love the risk-reward here. On the other hand, if the market rallies [in] the next four to 16 months, it is very hard for me to believe that financials are going to underperform that rally. So, if you think the market is going up, I would not be underweight [on] financials.
Doll: Underweight versus benchmark; but less underweight than we were before. In other words, we think that financials have bottomed. We think that their income statements will continue to improve, but their balance sheets still have some assets that are questionable. Therefore, I think that they're going to be less than market performance over the next year or two.
What are your thoughts on alternative energy?
Kelly: Alternative energy is a little bit like the Internet stocks of the late 1990s. Some of them are wonderful bargains, and some of them aren't. You really need to be an expert in the area to figure out which alternative will succeed from a market perspective, and which alternatives will find favor with Congress, and Congress seems to be directing the flow of money toward alternative energy. So I think you need to be an expert in alternative energy to make a bet on it.
Linehan: The real question is: What is the business? It's clear that demand is going to continue. [But] how valuable are these business models without subsidies, and what will the cost structure look like in terms of what's provided? Can they be cost effective in terms of the product they're delivering to the market place? It's a very interesting sector, but it's one where regulation and government intervention is an important driver for the potential [of] the industry itself.
Doll: I think that alternative energy gets more attractive as the price of oil goes up, and the economics around alternatives becomes more interesting. But at $70, alternative-energy projects are pretty mixed in their outlook. I want to own some, but I would be cautious because they're not particularly cheap.
Another way of saying that is every time I look at energy and decide to put more money to work, I generally go with the traditional energy companies because they're just so much cheaper than the alternative energy companies.
What are your thoughts on investing internationally?
Landesman: Ironically, this is a time when the U.S. is more attractive than some of the places around the world. The U.S. has actually been one of the poorer performing markets in the world this year. So I think you have a better valuation here.
I still like the odds for a U.S. recovery better than the odds for a European recovery; even though we saw some decent prints [GDP numbers] from Germany and France. I would argue that those prints aren't as meaningful as the press made them out to be because they were very, very depressed comparisons -- much more depressed even than the U.S. comps. So I'm actually more confident about the U.S. recovery than I am about the recovery in continental Europe.
Japan is a story I hate secularly. I think it's a market that will lose value over time, but it's been beaten up so badly that there may be a trade there in the near term.
Emerging markets have had a tremendous run. Secularly, if I could leave your readers with one message, it's you have to be exposed to emerging markets and particularly to the BRIC countries.
If you want to buy them a little cheaper, I can understand that, but the growth in the world is not coming from the U.S. It's not coming from Japan. It's not coming from the U.K. or continental Europe. It's really going to come from Brazil, Russia, India, and China, as well as from other emerging markets. So secularly, I think investors need to have at least 20% of their portfolios invested in emerging markets.
Doll: Not withstanding any correction, [...] over an intermediate, longer-term period, the clear preference is for emerging markets. [They possess] faster growth, stronger savings rates, and they do not have the credit noose around their necks like the developed world.
Within the developed world, the first choice is the U.S. We were first into the recession, and because of the aggressiveness in policy, we will be the first out. We think the leading indicators tell us that.
Japan's geographic proximity to emerging Asia and its exposure to the export markets put the country in second place for us.
We have Europe in third place. The concerns there are slow to reduce interest rates -- didn't reduce them fast enough, or far enough -- and the credit related to Eastern Europe that still plagues the financials there.
What are your favorite companies right now?
Linehan: We like Microsoft (Nasdaq: MSFT ) . It has a very reasonable valuation and potential new product cycle, which is typically a very potent combination. In the energy sector, Royal Dutch Shell is intriguing given that they're finally attacking the cost structure of the company. They have very good overseas, long-lived assets.
We like Southwest Airlines (NYSE: LUV ) . It's an example of a company that should be in a good position to take advantage of the economy when it improves. Within retail, a company that's attractively valued [and] that is taking share would be Kohl's.
Schaeffer: Netlogic, Palm, Atheros Communications, Expedia, Citigroup (NYSE: C ) , AutoNation, Brunswick, Starwood Hotels and Resorts Worldwide, Ralph Lauren, Starbucks (Nasdaq: SBUX ) , and Whole Foods Market (Nasdaq: WFMI ) .
Doll: I'll break down which companies I like via a portfolio approach. Within energy, you need oil service -- so, exposure to the commodity in a leveraged way. There, I like National Oilwell Varco (NYSE: NOV ) . I think you need exposure to exploration and production -- Anadarko would be my choice. Lastly, I think you need an integrated player. So let's go with one that has a little refinery capacity, exploration and production, and other integrated parts of oil. I'll pick Marathon for that one.
In health care, I think you want a pharmaceutical. So I'll go with Wyeth -- one of the four companies that's going to become two before long. I like Amgen (Nasdaq: AMGN ) in the biotech space, and UnitedHealth in the services area.
Finally, in technology, Hewlett-Packard is an interesting name that I think is undervalued. I also like IBM, which has transformed itself from a hardware company to a recurring software-services revenue company, and I think the multiple hasn't changed.
For more insight from these experts: