Favorable For Large-Cap
When it comes to market cap, large stocks are the primary beneficiary
of a slower-growth economy and investor flight to quality. "At this
stage in the cycle, the supply of earnings growth is starting to
shrink, so paying for predictability in growth makes sense," says John
Waterman, chief investment officer of Rittenhouse Asset Management, a
conservative large-cap growth manager in Radnor, Pa. "We think the
market will begin favoring companies that show consistent earnings
growth and have strong balance sheets," Waterman says.
Whether consumers finally quit spending is a crucial issue, he adds.
"Your stance on that matters a lot in where you put money within the
large-cap space." Investors foreseeing consumer caution might consider
conglomerate GE, with products in industrial and commercial markets
that can buoy earnings regardless of what consumers do. Waterman also
mentions certain types of health-care companies, including HMOs,
pharmacy benefit managers, medical device companies and diversified
organizations such as Johnson & Johnson.
Consumer-wary investors will probably want to avoid retail and consumer
discretionary stocks, Waterman adds. Those shares were already falling
by early autumn on initial fears of a consumer retrenchment. But they
could rebound quickly if people's purse strings don't actually tighten,
perhaps because of surprisingly gentler prices at the pump. Some
investors, including Buffalo Funds, have been scouting for bargains
when these sectors sell off.
Another idea for 2006 is mid-cap. The companies are decidedly safer
than small-cap names, yet have the ability to grow faster than large
stocks. "Mid-caps are in the sweet spot in the market," says Buffalo's
Gasaway. They're increasingly paying dividends, too, he says. "These
are successful businesses that generate lots of cash, at least the ones
we own."
Sectors to watch include technology. Grant Sarris, another Buffalo
Funds portfolio manager, says, "Tech stocks have underperformed for a
few years but their earnings growth has been reasonably solid, cash has
been building on their balance sheets, they're no longer diluting
shareholders by granting too many stock options, and in some cases
they're buying back stock." Proponents also argue businesses have
reigned in technology expenditures for years and that has created
pent-up demand.
And energy? Even if prices remain high due to climbing global demand
and limited refining capacity on the supply side, energy companies
aren't known for executing optimally. "They're notorious for
squandering capital," says Morningstar's Lyons. Better perhaps to
invest in companies that are likely to benefit from a Big Oil spending
spree.
"As the global leader in the oil services industry, Schlumberger will
be the first stop for most of the major integrated oils as they look to
develop existing reserves and discover new ones," says Bill Fries, a
portfolio manager and managing director at Thornburg Investment
Management Co., in Santa Fe, N.M. "Schlumberger is going to have
surprising demand for its services."
Opportunities Abroad
Because of the prominent role that the United States commands on the
global economic stage, one's view of domestic growth necessarily colors
one's outlook for the world. Fries says, "Because there is more of a
global economy than ever, and because of the large consumer economy in
the U.S., what happens here is pretty relevant to what goes on around
the world." He's looking for 3% U.S. GDP growth in 2006 (down from the
3.6% he anticipated earlier this year) and between 7% and 9% in China.
Even if the numbers are a tad lower than in recent years, that's still
plenty of grease for the wheels of international commerce.
Multinationals whose fortunes ride on global conditions could prosper
in the new year, says Guang Yang, a portfolio manager and executive
vice president of Templeton Global Equity Group. Yang's portfolios are
50% overweight non-U.S. compared to benchmarks and include holdings
such as Denmark's Vestas Wind Systems, a wind power turbine
manufacturer that has raising prices as the renewable energy movement
gains momentum globally. He also touts Endesa, a Spanish utility
deriving about 40% of revenues from outside its home market, a big
slice from Latin America.
One of Yang's top holdings is South Korea's Samsung Electronics.
"Samsung is a global IT [information technology] company that happens
to be in Korea," he says. "Its products are very competitive globally,
yet it's one of the cheapest IT companies in the world, trading at
about 12 times earnings [when interviewed]. "
Besides thinking globally, international investors should buy local
businesses in foreign countries. For one thing, owning companies
catering to the local trade provides diversification from
multinationals affected by global markets or generating significant
U.S. dollar-denominated revenues. It's also a way to capitalize on the
growth of a nascent economy. Two widely held financials are Kookmin
Bank in South Korea and OTP Bank, a Hungarian bank that's a play on
Eastern Europe, according to Lyons. "Both are involved in lending and
mortgages, two things that should do well when an economy prospers," he
says.
To Fries, the emerging markets are where you want to be, "in part
because they have farther to catch up. Places like China, India,
Eastern Europe, Russia, and even Latin America offer the best
opportunities," he says. Think about what's happened to cell-phone
proliferation in Russia as a case in point. Couple years ago, 40% of
the population had cell phones. Today it's probably 65%, Fries
estimates, although he adds that the penetration rate in nonurban areas
remains quite low so there's still opportunity.
Yang over-allocates to South Korea, which he believes will continue to
prosper despite the Korea Composite Stock Price Index's 32% run-up this
year (through October 24) and on the heels of double-digit returns in
2003 and 2004. "Many good companies in South Korea are still trading at
large discounts to their global peers, and they're growing faster,"
Yang says of the Chinese trade-partner. "South Korea has more way to
go."
Despite the Internet Age, gathering information on small foreign
companies remains a challenge. "That's why in emerging markets, it's
essential to have an experienced manager with an exacting research
bench that's willing to go the extra mile," says Lyons.
In the developed markets, Europe appears attractive for reasons
including cheap valuations. "One manager tells me that many European
stocks are three-quarters the price of U.S. stocks, and that even
though they may be growing more slowly, they represent better value,"
says Lyons.
Also favorable for European stocks is the corporate restructuring
that's going on there. Like many U.S. companies did some years back,
European businesses are cutting costs, implementing technology,
divesting noncore subsidiaries, focusing on return-on-equity and
generally shaping up. "That has just started to pick up in a big way in
Europe," Yang says.
Meanwhile in Japan, it's the same old story: Things are improving.
Finally. Slowly. Maybe. At any rate, Fries eyes opportunity in
financial services. The Japanese are big savers, don't forget. "They
have large cash balances," he says. "That's an area to pay attention
to."
