Related Story: A Brighter Idea from Philips
Video: Investing in Philips

In the long run, the growth opportunities are immense. After all, the U.S. population, and that of many other developed nations, is aging, and health-care costs are rising. That is likely to increase demand for Philips' health-care products such as remote monitoring devices for stroke patients. And the growing interest in energy efficiency is expected to drive future growth of the next generation of lighting known as light-emitting diodes (LED), a major focus for Philips' lighting unit.

The downside? It will take time for those trends to translate into a further pickup in Philips' share price. In recent years the company kept investors satisfied with consistent dividends and a sizeable share buyback program. The dividend remains safe. But in the short term, all three of Philips' businesses face serious pressures.

With LEDs, lighting faces the biggest technological innovation since the invention of the incandescent bulb, but amid the most difficult recession in recent memory. "The entire business model is shifting from one built around simply replacing bulbs to one in which lights are integrated into buildings, making it highly dependent on the construction cycle," says Prozesky.

A SHIFT UPSCALE

Consumer Lifestyle, Philips' appliance and consumer-electronics unit, also faces challenges. The company stopped making TVs worldwide, preferring to outsource manufacturing and concentrate on research and development and marketing. Now it's focusing on higher-end plasma and LED TVs as well as more upscale appliances including espresso makers and sonic toothbrushes. It is continuing to acquire niche companies, such as Avent, a mother and baby company, and Saeco, an Italian espresso maker. Still, analysts say there needs to be a dramatic pickup in premium discretionary spending before that business returns to growth.

While health care is expected to be a major driver of Philips' earnings and share price, the industry has its own set of thorny issues. A big one: U.S. health-care reform and what it will mean for insurance reimbursement policies for consumer health-care products. Also, governments and hospitals worldwide face financing constraints that could continue to crimp sales of medical equipment. And Philips' rivals General Electric and Siemens are making significant inroads into the home health-care market, which Philips used to dominate. "The intense focus on the health-care business since 2008's third quarter has acted as a drag on share price," says Peter Olofsen, an analyst at Kepler Capital Markets in Amsterdam.

After hitting bottom in 2009's second quarter, when sales plunged 19%, Philips' revenue growth is expected to remain negative for the remainder of 2009, according to analysts. In the third quarter, the decline slowed to 11%. Even so, Philips' shares have gained 30% so far this year, thanks in part to its aggressive cost-cutting measures. Now, in its leaner, more focused state, the company seems to have found the right business model. But "it will take a few more quarters before Philips returns to positive growth," says Olofsen.

By Kerry Capell

Related Story: Taiwan's New Dreams
Video: Investing in Taiwan

Taiwan’s bourse is home to a few truly global tech companies, including the world’s largest producer of outsourced chips, Taiwan Semiconductor Manufacturing. Many of Taiwan’s major tech stocks trade as American depositary receipts in the U.S., but its market still behaves like that of an emerging economy. “Investors have to be aware that it’s very volatile,” warns Renee Hung, deputy chief investment officer at Hong Kong-based Value Partners.

After such a rapid rebound, is Taiwan’s market overheated? Not when you take into account expected earnings growth, says Mike Shiao, who manages the Invesco Greater China Equity Fund in Hong Kong. “We definitely do not think it’s expensive, though it has a 2010 price-earnings ratio of 16, compared with a non-Japan Asian average of 14,” he says. “That’s because Taiwan has much stronger earnings growth of 67%, compared with 27%” for Asia without Japan. For investors who want broad exposure to Taiwan’s market, there is an iShares MSCI Taiwan Index Fund, as well as a closed-end fund, the Taiwan Fund.

William Tung, chief investment officer of JPMorgan Taiwan Asset Management, says cost-cutting has been “a mantra” for Taiwanese stocks and that they “have fine-tuned operations so well that after the [down] cycle they are healthier than before.” Prices have fallen so much that electronics are affordable for many consumers in emerging markets, he says. Those markets account for some 50% of end demand for information technology products.

Shiao’s tech-heavy fund owns Taiwan Semi as well as electronics component supplier Hon Hai Precision Industry. Taiwan Semi got some good news recently. It won a $200 million settlement from Chinese rival Semiconductor Manufacturing International for trade secret theft. The settlement includes an option to buy up to 10% of SMIC, which would give Taiwan Semi a strong foothold on the mainland.

OVERTAKING DELL
A company Tung says has emerged from the crisis with better margins is Quanta Computer, one of the biggest makers of notebooks for Hewlett-Packard, Dell, and others. The company has won a number of new contracts for next year. Says Quanta Chairman Barry Lam: “Next year the industry will grow by 20%, and we will grow by 40%.”

Some of Taiwan’s tech companies are also poised to benefit in the post-PC era as mobile devices acquire more functions of the traditional computer. AUO, the world’s third-largest LCD panel maker, is preparing to manufacture for a rival to Amazon.com’s Kindle e-reader. AUO’s biggest Taiwanese competitor, Chi Mei, the world’s fourth-largest LCD maker and a major supplier to Chinese television makers, is benefiting from strong local demand.

Value Partners’ Hung is also keen on tech and is impressed by smartphone maker HTC. It launched the first Android smartphone last year and came out with the $180 HTC Hero for U.S carrier Sprint. Hung says the HTC Hero is giving the iPhone a run for its money.

Investing opportunities outside the tech industry are emerging as relations between China and Taiwan improve. In addition, reductions in taxes on capital gains and inheritance are helping to reverse years of capital flight and boost domestic spending. Taipei-based retailer Far Eastern Department Stores has been a beneficiary of that: Its shares have more than doubled since January.

By Frederik Balfour

Spain is expected to experience another year of economic contraction in 2010, but that bleak outlook hasn't put a big damper on the country's stocks. MSCI's index of Spanish companies lost less in 2008 than the MSCI index that tracks the European Monetary Union, and so far this year Spain's 33% gain tops the overall euro zone's 20%. By Tara Kalwarski

Related Story: Spain: Seeking New Worlds to Conquer
Video: Investing in Spain

THE HOT AND THE NOT
Financial companies in the MSCI Spain Index are projected to experience weak earnings growth in 2010, while telecom and energy companies are expected to see double-digit increases. (Data: Bloomberg; *Projected; as of Nov. 2)

ENERGY EXPOSURE
Investors can use these two funds to gain exposure to Spanish renewable-energy companies; their top holdings include EDP Renovaveis, Acciona, and Iberdrola Renovables. (Data: Morningstar)

CHARTS BY RAY VELLA/BW

With a flood of new issuance and year-to-date gains averaging 50%, there's worry of a bubble in high-yield bonds. Rising prices have sent average junk yields from 15% in February to 9% in October. Investors who still want in should proceed with caution and spread their bets. By Lauren Young, with Tara Kalwarski

Related Story: Are Junk Bonds Too Hot to Handle?
Video: Investing in High-Yield Debt

SLICING UP JUNK
These three mutual funds, which focus on higher-quality junk bonds, have delivered above-average returns over the long run and have low expenses.

HIGH YIELD'S RAPID RISE
After falling off a cliff late last year, high-yield bonds have been climbing back. Their recovery has them outpacing U.S. Treasuries and investment-grade debt.

Related Story: Mr. Clean Up

THREE WAYS TO GO

RACKING UP RESERVES
These regional banks have increased their number of branches and other retail outlets during the past year, which may give them an advantage as the industry recovers.

Related Story: The China Hype
Video: Investing in China

CHINA RISING
China's benchmark index is beating the S&P 500-stock index this year.

RED CHIPS
These China-centered funds are run by pros who have delivered stellar long-term performance by focusing on companies that have dominated the country's competitive landscape.

INDUSTRIES ON THE MOVE
Shares of technology and communications companies in the Shanghai Composite haven't been the index's best performers in the past year, but investors can take advantage of pockets of innovation in these two sectors via American depositary receipts (ADRs).

Related Story: What Happens if the Dollar Crashes
Video: Investing in the Weak Dollar

DIVERSIFYING OVERSEAS
Investing in foreign equities used to be a pricey proposition for retail investors. These mutual funds come highly rated by Morningstar and offer a range of geographic mixes.

*As of Oct. 12; multiyear returns are annualized. Data: Morningstar

A SMALLER U.S. SLICE
Overseas stocks now account for a larger share of the world market, with U.S. equities dropping by almost 10 percentage points over the past five years. Consider changing your international exposure to mimic the global mix.

*As of Oct. 8 in U.S. dollars

Related Story: Betting Big on a Boom in Natural Gas
Video: Investing in Natural Gas

COMPANIES VS. COMMODITY
An exchange-traded fund of companies that generate the bulk of their revenue through natural gas exploration and production is up 40% in 2009, vs. a 48% loss for an ETF tracking the price of the commodity.

ENERGY FUND OPTIONS
Fidelity offers a mutual fund focused solely on natural gas. But because the commodity is highly volatile, holding a diversified basket of energy stocks is a lot safer.

PIPELINE PICKS
Because natural gas is hard to move, there can be big fluctuations in inventories of it, which ultimately affect pricing. Companies that build pipelines could benefit from increased infrastructure spending.

Related Stories: J&J Tries to Buy Itself a Pipeline | J&J Bets on Vaccines
Video: Investing in Johnson & Johnson

Since the market bottomed in March, J&J shares have recovered, currently standing at about 61. Analysts who follow the health-care sector say there’s more good news to come, and the shares remain a solid long-term bet.

The company is gearing up for growth with smart acquisitions, according to Herman Saftlas, an analyst at Standard & Poor’s Equity Research. It closed a $1 billion deal for Cougar Biotechnology in July, so it now owns the upstart’s promising array of cancer medications. The deal follows an ongoing string of successful acquisitions starting with the drugmaker now called Centocor Ortho Biotech Products, which it bought for $5 billion a decade ago, he says.

Analysts expect J&J to continue making modest acquisitions of promising smaller companies while shunning the megadeals that some of its rivals have done. “This is their philosophy, and this is what has worked for them for a while,” says Saftlas. “I don’t see them going for a major merger.”

"POTENTIAL BLOCKBUSTERS"
Like other drugmakers, J&J is suffering in the short-term as some of the company’s best-selling drugs lose their patent protection. For the first six months of 2009 pharmaceutical sales declined 12%, to $11.3 billion. Epilepsy treatment Topamax and antipsychotic treatment Risperdal generated combined revenue of over $6 billion in 2008. But sales are dropping this year, courtesy of generic copycats that have grabbed market share after the expiration of the patents for Topamax in March and Risperdal in June 2008.

The drug division should be able to get back on track over the next 18 months with as many as six potential blockbusters, says Morningstar analyst Damien Conover. Several of those products could exceed $1 billion in annual sales, he notes. A promising pain medication, ­Tapentadol, was launched in June. The company could also regain market share for the treatment of epilepsy with a drug called Comfyde. But Conover says approval from the Food & Drug Administration is far from certain, and discussions with the agency are ongoing. Other future products offer treatments for arthritis and cardiovascular problems. “It’s hard to find any other company that has as many drugs that could hit the $1 billion mark,” he says.

Meanwhile, the company’s consumer segment, which sells everything from Band-Aids to baby shampoo, has been hit by the economic downturn. Sales in 2009’s first half slipped 7%, to $7.6 billion. The division should benefit from an improving economy over the next few years.

The risks to health-care companies from reforms in Washington have also held back J&J shares. But reform could end up helping the company’s bottom line. That’s because the drug industry is negotiating limited price cuts while pressing for broader insurance coverage. The situation is “most likely a wash” for J&J, but it could easily turn out better than many investors expect, says Conover. “The outlook is so negative, there’s potential for upside on the stock,” he says.

By Aaron Pressman

Related Story: The Peril and Promise of Investing in Russia
Video: Investing in Distressed Assets

AN OIL-SOAKED ETF
Almost half of the Market Vectors Russia ETF is composed of energy companies, including four of the top five. Among that group, however, the lone financial company is the top performer.

NOT FOR THE FAINTHEARTED

FROM RUSSIA, WITH RISK
The volatile returns of the three U.S. mutual funds that focus almost exclusively on Russia have resulted in high risk ratings from Morningstar.

By Tara Kalwarski and Ben Levisohn

Related Story: The Stock Market: Searching for True North
Video: The New Normal

There’s a certain Biblical undertone to the new normal orthodoxy: After decades during which consumers lived beyond their means, the nation must now endure a long stretch of lean years during which consumers pay down debt. In the minds of Gross and Pimco colleague Mohamed El-Erian, the prospect of a period of no growth means investors should hold as little as 30% in stocks, vs. the 60% long deemed the proper mix. They also recommend holding more fixed-income assets like bonds and bank loans, as well as commodities.

The risk for investors is that the new normal proves to be merely the latest investment fad, and by moving into bonds they miss future rebounds in stocks. “The new normal is just a different way of saying ‘It’s different this time,’ and that’s often a recipe for disaster,” argues Barry Ritholtz, chief executive officer of Fusion IQ, a quantitative research firm. “The mathematician in me says we’re just reverting to the mean.” Ritholtz believes the U.S. will recover, but it may need years to work off its 25-year debt binge. He sees “a lot of parallels” between now and the 1973-74 recession, a downturn he says that serves as a good composite of the 19 previous bear markets. Then and now, the market fell more than 45%, then rebounded 60% to 70% (chart). If past is prologue, Ritholtz thinks there could be another leg down, a few years of treading water—and a powerful bull market starting around 2012 or 2013.

Ritholtz and other pros believe the best strategy for many investors may be to beef up stakes in fixed-income and alternative assets but maintain enough exposure to stocks to profit from the rally the “old normal” crowd believes is inevitable. Robert Arnott, head of Research Affiliates, a research and analytics firm in Newport Beach, Calif., thinks investors would do well to build a portfolio split into five even baskets: U.S. stocks paying healthy dividends, stocks and bonds from mature foreign economies, stocks and bonds from emerging markets, stocks and bonds built around oil and other commodities, and 20% in bonds, including Treasury inflation-protected securities, which pay a return based on inflation. He suggests owning some “assets that other investors are afraid of” in each basket, such as high-yield bonds.

Arnott’s approach gives investors a roughly 50% weighting in stocks, but that comes from economies that could grow faster than the U.S. And it incorporates exposure to commodities that should fare well in any rebound—and provide a hedge against a surge in inflation. It’s a portfolio that could produce the best of both worlds: a blend of assets that generates income during lean times but provides upside if the new normal isn’t so new after all.

IF THE PAST IS PROLOGUE...
Analyst Barry Ritholtz sees parallels between today and the 1973-74 recession, which he says argue for a powerful rebound around 2012.

By Dean Foust

Related Story: How Real is the Rally in Real Estate Bonds?
Video: Investing in Distressed Assets

Since the start of the year, four new real estate investment trusts have raised $1.8 billion, according to Renaissance Capital, a Greenwich (Conn.) firm that tracks initial public offerings. An additional 18 are in the works, with plans to raise $6 billion. Investors should proceed with caution, says financial planner Harold Evensky. He adds: "I get nervous whenever Wall Street touts something as the hot product."

Distressed investing requires a strong stomach. More than 13% of home loans were delinquent or in foreclosure in the second quarter, according to the Mortgage Bankers Assn. For subprime loans, that number was 40%. Meanwhile, delinquencies of commercial mortgage loans—which tend to trail their residential counterparts—topped 4% in August, compared with less than 1% the year before, according to Trepp, a provider of data about commercial mortgage-backed securities (CMBs).

Adding to risk now is that the market for residential and commercial mortgage bonds—especially, the AAA-rated ones—has rallied strongly since its March lows. "A lot of money is chasing an asset whose fundamentals haven't changed," says Thomas Atteberry, co-manager of FPA New Income Fund. "We think it is somewhat early to do this." But while AAA-rated bonds are up sharply, many BBB-rated ones still trade for less than 20 cents on the dollar. As Manus Clancy, a senior managing director at Trepp, says of the low-rated CMBS: "I think people are pricing them to the worst-case scenario."

While the spotlight has been on the residential market, the commercial market may offer better opportunities. One reason is uncertainty over how the government's role in home loan modifications might change. Two of the most experienced distressed investors, Colony and Apollo, target commercial mortgages.

An alternate, far riskier approach is the one taken by PennyMac, which is run by a former executive of onetime mortgage giant Countrywide Financial. It buys portfolios of home loans from banks and the Federal Deposit Insurance Corp. PennyMac has its own loan servicer, which seeks to renegotiate its distressed loans to avoid foreclosures.

Investors should check the manager's expertise, of course—particularly if it will need to negotiate with homeowners facing foreclosure. They should also consider that some REITs have hedge fund-like fees—1.5% management fees plus a significant share of any profits.

A more cautious way to invest is through mutual funds such as TCW Total Return Bond Fund. It returned 14.6% over the past year. Perhaps tellingly, manager Jeffrey Gundlach has been reducing exposure to riskier nonagency bonds (bonds not backed by Fannie Mae or another quasi-governmental institution) as the mortgage market has rallied.

By Amy Feldman and Christopher Palmeri

Related Story: Oracle Has Customers Over a Barrel
Video: Investing in Tech Giants

Once mainly a hardware vendor of computers large and small, IBM (IBM) has used a sharp acquisition strategy to expand into software and information technology services. After a string of successful additions, including performance management software maker Cognos, and Rational, which makes tools to help programmers write code, IBM announced in July it would pay $1.2 billion for SPSS, a leading developer of software to analyze statistical data. "All the software acquisitions have helped shift the company toward higher margins and faster growing areas," says Ken Allen, manager of the T. Rowe Price Science & Technology Fund. IBM was his 15th largest holding as of June 30.

Salesforce.com (CRM) has always been a poster child for the move from desktop applications to Web-based products. As more computing and data storage have migrated to online servers—the clouds in "cloud computing"—Salesforce has used a series of small acquisitions to keep pace. In 2006 it grabbed wireless software developer Sendia, for example, helping make all its offerings available over mobile phones. "They're doing a good job of pushing each acquisition into their services," says Jeff Kaplan, founder of tech consulting firm Thinkstrategies.

Cisco Systems (CSCO) is the king of bolt-on acquisitions. In a typical deal, Cisco purchases a much smaller company, such as voice-over-Internet gearmaker Sipura, which it bought for $68 million in 2005. Then it uses its manufacturing smarts and sales force to promote cutting-edge products that often fit into existing lines of business. Cisco also uses purchases to diversify and get into new businesses. This year it added Pure Digital Technologies, maker of the Flip digital video camera. "Their goal is to become a larger player in the consumer electronics and networking business," says Ned Douthat, an analyst at Ockham Research in Roswell, Ga.

One company that Richard Parower, manager of the Seligman Global Technology Fund, says never quite makes the right deal at the right price is Microsoft (MSFT)—"the one glaring example of [tech companies] that can't do acquisitions." For example, Microsoft paid more than $6 billion for Web advertising company aQuantive, a price several investors say was far too high. And its on-again, off-again talks to buy Yahoo! have shareholders worried about another surprise deal. T. Rowe's Allen thinks "investors are still discounting the probability they'll do something so risky again." A Microsoft spokesman says: "We buy where it makes sense, where we can accelerate growth, and generally we buy companies early in their history."

Another loser, say investors, is mobile-phone manufacturer Motorola (MOT). "Remember Symbol Technologies and Good Technology, both acquired by Motorola?" says Eric Jackson, founder of Naples (Fla.) money manager Ironfire Capital. "They have disappeared off the face of the tech landscape." Motorola says it's pleased with both deals and notes that Good's programmers are central to building products that use Google's Android mobile-phone software.

By Aaron Pressman

Related Story: The Return of Capital Spending
Video: Investing in Infrastructure

Some stock market strategists say early signs of loosening corporate purse strings mean now is the time to buy shares of tech behemoths, as well as industrial goods makers and transportation companies, that will see an uptick in orders as businesses bulk up again. "You want to be in trucking, heavy machinery, industrial companies, mining and minerals," says James Swanson, chief investment strategist at MFS Investment Management. "It's Old World industries and tech—a Jekyll and Hyde theme."

But with the iShares S&P Global Industrials Sector Index Fund, an exchange-traded fund loaded with big industrial companies, already up 60% from the stock market's March low, investment managers such as Arthur Moretti of the $900 million Neuberger Berman Guardian Fund prefer to look farther afield. Moretti scouts for companies that have invested in research and development and created proprietary products that will benefit from a rebound in business spending. His favorite holdings include Altera, whose programmable chips are used in medical equipment and industrial automation gear. He also likes Intuit. The company, best known for its TurboTax consumer tax preparation software, generates one-third of its sales from units that supply small businesses with payroll processing, accounting, and credit-card payment software. Intuit expects earnings per share to climb 10% to 16% for the fiscal year that just began.

Karl Mills, portfolio manager of the Counterpoint Select Fund, also tries to get in front of big waves of business investment. He figures companies will need to invest in wireless technology because it enhances productivity and because there's a natural cycle of obsolescence in technology that requires more spending. Some of his largest holdings are Cisco Systems, the king of Internet routers; data storage leader EMC; and Qualcomm, which owns much of the technology needed for next-generation wireless data services. Such companies are already big players, but in difficult markets "the stronger not only get stronger, they get much stronger," says Mills.

Since all of that new high-tech gear requires juice to run, Mills also thinks it is early days for a surge of investment in electricity generation and power-saving devices. To play that trend, the fund manager holds large stakes of General Electric, Siemens, and Swiss industrial giant ABB.

FOLLOWING THE MONEY
These sectors and companies should attract increased capital spending, say fund managers

SEMICONDUCTORS
Chipmakers with proprietary products, such as Altera, could profit from a pickup in capital expenditures.

WIRELESS
Any technology that can enhance productivity, such as wireless, should benefit. Cisco, EMC, and Qualcomm should continue to do well.

POWER
Bigger outlays for tech may mean a greater need for electricity and power-saving devices, so GE, Siemens, and ABB could gain.

By Christopher Palmeri

Related Story: A Radical Rethink of R&D
Video: Investing in the Future of Tech

Coburn's fund doesn't just buy and sell technology stocks short. When it comes to making bets on how major tech trends may help or hurt different industries, the fund casts a wider net than many of its peers. Coburn foresaw how the Internet would destroy the newspaper industry's business model and shorted the sector back in 2007, for example. Lately, Coburn sees about two dozen serious tech-related shifts on the horizon. Here are three of the major themes he is following now and some stocks in his fund that may benefit.

DATA, WITH A TWIST
The theme: With more and more of people's lives being led online, from entertainment to communication and commerce, the world is awash in a sea of data. "There is so much data out there today, it's not O.K. just to have a massive amount [of it] anymore," says Coburn. "Now companies had better figure out how to use it wisely." To make a difference to the bottom line, companies have to harness the data and offer a twist—make it mobile or deliver analysis quicker.

The play: ANSYS, a data-modeling company outside Pittsburgh, uses "real world" data to create computer models. Its programs do everything from measuring car safety without a single crash-test dummy to figuring out how giant cargo ships can be designed to stand up to stormy ocean conditions. The company's operating profit margin is more than 30%, and revenue grew an average of 45% a year from 2006 through 2008. Shares of ANSYS, which are down 18% for the year, recently jumped to 36 from 31, on better-than-expected earnings.

POPULATION CHANGE
The theme: Human population has doubled over the past 50 years and could double again, to 14 billion, in the next 50. That means more demand for food, energy, and everything else even as the availability of natural resources diminishes. Coburn says the trend will boost a wide array of industries such as water, alternative energy, and "clean tech" providers.

The play: Monsanto, the seed and herbicide giant, will be one of the biggest beneficiaries as the population increases, says Coburn. Even if the figure levels off in the next few decades, farmers will still need to grow more crops more efficiently. So Monsanto's innovations in agriculture will be in high demand, he figures. The stock is down 31% in the past year and trades for less than 20 times its expected 2010 earnings.

DIGITAL DEMOGRAPHICS
The theme: Older folks who were not weaned on technology are increasingly interested in getting up to speed, whether it's to succeed at work or look at photos of the kids online. They are in search of what Coburn calls "digital ferrymen" who can assist them.

The play: One obvious beneficiary of this theme is Apple, which emphasizes how easy it is to use its software and hardware products, says Coburn. Another company he says is well-positioned is Strayer Education, which operates adult education schools in 12 states and is expanding rapidly. Revenue was just under $400 million last year with almost 45,000 students enrolled. "It's still a modest company," says Coburn. "But they could become the dominant brand—a household name—over the next few years."

By Aaron Pressman