Chance at glory for stock pickers

Equities: Once you've picked out, say, a health care stock or an REIT, you've got to know when to hold them, and when to sell them.

Stock market

January 20, 2002|By William Patalon III | William Patalon III,SUN STAFF

While there most likely will be a stock market rally in 2002, it won't be the kind of broad-based rally where investors can just buy an index fund, sit back and profit, many experts say.

It's going to be a stock-picker's market, they say.

"The market as a whole won't go up, but individual securities will," said David Citron, a managing director for the local office of Carret and Co., a New York money-management firm. "That's where you'll have to spend your time, picking individual securities."

With the U.S. economy poised to rebound from its first recession in a decade, and the major stock indexes having declined for two straight years, the experts say the stock market is primed for a positive year.

Even so, professional investors aren't expecting huge gains: Most experts are predicting a return for the year of 9 percent to 12 percent, roughly in line with the long-term historical average for stocks.

"If the [Standard & Poor's 500 index] does more than 10 or 11 percent for the year, I'd be surprised," said Phil Dyer, a senior manager with Wealth Management Services in Towson. "It's much more likely that returns will be in the 9 to 11 or 9 to 12 percent range."

Numerous factors favor a rally in the major indexes.

First, stocks declined in both 2000 and 2001, only the fourth time in modern history that the major indexes posted back-to-back losses, said Robert Mewshaw, president of Van Sant & Mewshaw, a Lutherville money-management firm.

In fact, since 1900, the Standard & Poor's 500 index has declined three straight years only once - from 1929 to 1931, during the Great Depression. In the three other times stocks have suffered back-to-back declines, share prices have always risen at a double-digit clip in the year that followed.

"History is on your side for a positive market return this year," Mewshaw said.

Second, thanks to 11 interest-rate cuts by the Federal Reserve, short-term interest rates are at 40-year lows. That makes stocks much more attractive to investors than low-yielding bonds, money-market accounts or certificates of deposit. What's more, it lowers the borrowing costs for U.S. companies, which should help increase their profitability. And when profits increase, share prices usually advance beforehand.

And finally, the American economy is expected to rebound in the second half of this year, another boost to corporate profits. Since stocks tend to rally six to nine months ahead of an economic turnabout, share prices should rally in the first half of this year, many experts say.

"I think the first half of the year" will be strong, with the S&P 500 reaching 1,300, for a return of about 12 percent from the year's outset, said Richard Cripps, chief market strategist at Legg Mason Inc. "That's on the [potential] for a recovering economy. Once we get there, and go into the second half of the year, the market will be flattish, if not lower."

Naturally, there are no guarantees of a market resurgence. Because of the huge rallies in the late 1990s, many stocks are still richly priced, despite the losses of the last two years. That priceyness will likely reduce the room shares have to run, experts say.

And while borrowing costs are low now, as the economy strengthens the Fed is sure to boost rates to keep inflation at bay, many experts predict. If those increases are aggressive, they could stymie the growth in corporate profits and consumer spending, slowing the economy's advance and causing stocks to retrench.

"Frankly, one of the main concerns for next year is if the Fed raises rates, and when they do it," Carret and Co.'s Citron said.

All these competing forces will make for a challenging environment for investors, meaning that picking the right stocks is paramount.

Professional investors all have their favorites.

According to Legg Mason's Cripps, dividend income will be crucial to investing success. Electric utilities - many of them hit hard by the Enron debacle - are one place to look for high-yielding stocks. Real estate investment trusts, known as REITs, are another, Cripps said.

Health care is another sector to sift through, since America's aging population means the demand for health care services is going to grow, Cripps said.

He warns investors to avoid financial services and consumer cyclicals.

Buying S&P 500 index funds - the dominant investing strategy just a few years ago - is definitely not the way to go in 2002. "Don't be in the S&P 500," he said. "Active management is more likely to succeed, playing the whole field."

And, if you suddenly find yourself with a big profit in a stock, don't be afraid to lock in the gain by selling it. "If I tell you the one biggest factor [to succeeding this year], it's having a sell discipline - knowing when to sell," Cripps said.

Mewshaw, the Van Sant & Mewshaw president, advises investors to look for "small-cap value" stocks - smaller public companies whose share prices have lagged.

Carret and Co.'s Citron is actually looking at very specific stocks: technology-products provider TRW Inc., financial services provider Lincoln National Corp. and medical-devices maker Guidant Corp.

According to Citron, it's critical to look at a stock's price/earnings ratio, as well as the projected earnings of the underlying company. If the P/E is high - meaning the stock is pricey - and the projected rate of earnings growth is low, an investor might do well to avoid that stock. The reason: Investors will be quite unforgiving if the company disappoints, or if there's a market downturn.

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