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Gene Marcial's Stock Picks

Marcial: A Fool's Rally?

A fool's rally. That's how skeptics explain the stock market's 24% advance since the Dow Jones industrial average hit a closing low of 6,547.05 on Mar. 9. But is the unexpected upturn just a teaser—that is, a rally in a bear market?

The tug-of-war between the bulls and the bears rages on. Indeed, with the economy reeling, joblessness on the rise, housing in the dumps, and the financial crisis still unresolved, there are enough reasons to be wary.

One who is leery of the durability of the market's advance is Wall Street Journal columnist Justin Lahart. In a column last week he noted: "The Dow Jones industrial average is up 21% from the 12-year low it hit last month, and it isn't hard to come up with reasons the rebound makes no sense." And for "all the talk of economic recovery, what signs there have been are truly fragile, as Tuesday's disappointing March retail-sales report demonstrated," he added.

However, my colleague Michael Mandel, BusinessWeek chief economist, takes the contrary view. In his Mar. 25 column, Mandel prognosticated that "this market rally may be for real." One argument buttressing his optimism: "Since the [market's] low point [in March], the Federal Reserve and the Treasury have unveiled plans to pour as much as $2 trillion into the financial markets. That's a lot even in an economy as big as America's."

A Narrower Trade Deficit

In the meantime, the economy has shown tentative signs of coming back to life, notes Mandel. For example, on Mar. 25, the Census Bureau announced that new orders for durable goods, such as computers, rose by 3.4% in February, the first gain in seven months. Equally important, he says, the trade deficit in January narrowed to an annual rate of $430 billion, or 3% of gross domestic product, down from 5% a year ago. Mandel argues that as the trade deficit shrinks, the U.S. has to borrow less from China and elsewhere to finance imports, which means America's financial markets become less vulnerable in other parts of the world.

This week, some good news came on the earnings front. General Electric (GE), JPMorgan Chase (JPM), and Citigroup (C) reported healthy first-quarter earnings that beat Wall Street's forecasts.

Is there a middle ground in this debate? There is. Economist Ed Yardeni, president of Yardeni Research, believes the March low was indeed "the low for this bear market," but asserts that bear markets aren't always followed by bull markets. "We may be in a bottoming market, rather than an up-up-and-away bull market," he suggests.

So, what should investors do now? It's clear that many are taking advantage of low stock prices, as the market's massive meltdown has provided a boatload of opportunities. (The Dow has lost some 44% from its record close of 14,164.53, hit on Oct. 9, 2007.) Without doubt, stocks are priced at truly bargain levels, based on almost every market benchmark, including price-earnings ratios, cash flows, and intrinsic values relative to assets.

Where is the buying coming from? The billions of dollars that have been sidelined by reluctant investors in the U.S. and abroad will be the drivers of the market's next massive bull move. "As a result of the many months of market declines, there are now many trillions of dollars [historically record levels] on the sidelines waiting for the opportunity to achieve better returns [in the stock market] than those offered by cash," says investment manager Arnold Schmeidler, president of A.R. Schmeidler Investment Advisors. And as "we emerge from this period, the great values that are being created could result in investment returns that are the most attractive that have been seen in years."

the tough go shopping

The clichÉ "you have to be in it to win" is germane and matters most in this market environment. Already many individual investors, and not just professional traders, have racked up significant gains on stocks they seized since the March lows.

One investor who acted swiftly was Gregory MacArthur, president of investment consultant Viewpoint 2000. When the market plunged on Mar. 9, he became convinced that the market was finally establishing a base and setting the stage for a broad rally. So he boldly started buying his favorite big-cap stocks that have been hammered in the market's selloff in spite of their continued robust business fundamentals.

MacArthur concentrated on shares of Apple (AAPL), which has risen to 122 from 83 on Mar. 9; Caterpillar (CAT), now at 32, up from 23.25; Conoco Phillips (COP), 39 from 35; ExxonMobil (XOM), 67 from 64; International Business Machines (IBM), clear to 101 from 86; Johnson & Johnson (JNJ), 52 from 47; Microsoft (MSFT), 19 from 15; Pfizer (PFE), 14 from 12.50; Union Pacific (UNP), 47 from 35; and Williams Cos. (WMB), which has advanced to 13 from 10.

Richard Steinberg, president of the Steinberg Global Asset Management in Boca Raton, Fl., points out that in every market climate, regardless of valuations, there are opportunities. Investors should figure out "which sectors represent the best prospects to grow capital regardless of market or emotional extremes," he says. Steinberg isn't fully convinced that the market will blast off from current levels. "The market's current valuations are a bit better than average, yet not high enough to warrant a major selloff," he says. At the same time, however, "it is not necessarily low enough to support a sustained long-term rally."

"opportunity for long-term investors"

Nonetheless, he was among the pros who took advantage of the market's fall. One stock he believes has been unjustifiably pounded: Abbott Laboratories (ABT), which hit a high of 60 on Sept. 16, 2008, and is now at 43, not far from its low of 41.88 hit on Apr. 15, 2009. "It is a very cheap stock with good prospects for low double-digit earnings growth, with a solid 3.7% dividend yield. Abbott's pullback has created an opportunity for long-term investors," says Steinberg.

Part of the stock's recent weakness was the lower-than-expected sales of Abbott's blockbuster drug Humira, which accounted for 15% of the company's global sales. Analyst Stephen O'Neill of investment firm Hilliard Lyons, who rates Abbott a long-term buy, has a two- to three-year price target of 75.

Arnold Schmeidler recently purchased shares of Potash ((POT), one of the world's largest fertilizer companies and the world's largest potash producer, mainly because he thinks it will see an upsurge in earnings over the next 12 months. He anticipates a posting of more than $10 a share in 2009 and $15 in 2010. Schmeidler says China and Brazil are expected to place huge orders for potash.

Shares of Potash plunged to 86 on Apr. 17 from a high of 239 hit on June 17, 2008. Part of that massive decline had to do with some disruptions in the company's production facilities. Schmeidler has a 12-month target of 140. The stock's decline has generated speculation that Potash may be a takeover target.

William Harnisch, president of hedge fund Peconic Partners in New York City, has also been hunting for bargains, but he limits his picks to companies with products that are recession-resistant, generating strong cash flow, and experiencing steady earnings growth. One that fits the bill, he says, is Varian Medical Systems (VAR), a leading maker of radiotherapy systems for cancer and major supplier of X-ray tubes and flat-panel digital systems for imaging for medical, scientific, and industrial applications.

Varian's stock has also been crushed, to 33 on Apr. 17 from 64 on Aug, 15, 2008. Harnisch notes that recently Varian has improved its radiation therapy systems by making them even more precise in targeting cancer cells. "The company has been able to continue growing despite the tough economic and financial environment because of the steady demand for its products," he says. Analyst Dalton Chandler of investment bank Needham, who rates Varian a buy with a 12-month target of 52, figures the company will earn $2.61 a share in fiscal 2009 ending Sept. 30, and $2.95 in 2010, up from 2008's $2.19.

In the meantime, the stock market will continue to do what it does best—baffle the undecided investors and those who prefer to sit on the fence.

Marcial writes the Inside Wall Street column for BusinessWeek. In 2008, FT Press published the book Gene Marcial's 7 Commandments of Stock Investing.

Marcial writes the Inside Wall Street column for BusinessWeek. In 2008, FT Press published the book Gene Marcial's 7 Commandments of Stock Investing.

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