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During the past 20 years, the author has watch China move from being a developing country into an industrial superpower
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Get Four
|  | JANUARY 6, 2006
A Capital-Spending Bonanza?[Page 2 of 2]Do you believe energy stocks will keep leading the market, or will other groups take the reins? With our forecast for energy prices I'm hard pressed to make the case that energy stocks, whether it be natural gas or oil, domestic or foreign, will advance much from the valuations they enjoyed in '05. High energy prices don't usually beget ever higher prices -- usually the opposite. I would be inclined to take profits from the group. I think refiners, who are maxed out in their capacity, won't be able to grow their production unless they make substantial investments. So we will be a net seller of this group that provided market leadership in the past. What stocks or sectors are you most bullish about for the new year? Health care and technology. We've already discussed tech, but in health care we see an improvement in investor expectations for the large cap pharmas, from Pfizer (PFE ) to Bristol-Myers Squibb (BMY ), Merck (MRK ), etc. We'll also have the continued march from biotech companies bringing out products and having high growth rates, names like Genentech (DNA ). The medical-device companies will also do very well…. Generics will also have a place, because the two main themes for health care are the aging population and the drive for limiting health-care costs. You cited medical devices and generic drugs as areas of health care you liked -- any specific stocks for us there? I would mention AstraZeneca (AZN ), Cardinal Health (CAH ), and Caremark (CMX ). Joe, what are your targets for the Dow, S&P 500, and NASDAQ? And what about the federal funds rate? I expect by yearend next year the Dow Jones will be at 11,650, the S&P 500 at 1350, and the NASDAQ composite at 2570. As far as the fed funds rate goes, we have an expectation that the Fed will stop between 4.5% and 5%, and I'm starting to think 4.5% is more likely, which will coincide with the end of Greenspan's tenure. Now, over the course of '06, we may see higher highs than these targets, but that's the nature of the market. These would be fairly healthy returns for year four of this bull market. A lot of market watchers have been predicting large caps and growth stocks would outperform smaller and value stocks. What do you think? We started to beat that drum in the second half of this year when it comes to large cap vs. small cap and growth vs. value. We still think that premise will lurk, but I'm not convinced it's going to be an overwhelming bias, and I say that because while large caps have underperformed and small caps have enjoyed valuations shooting upward, small caps still have decent earnings power, while some large-cap companies in categories like energy and financial services might have a more difficult go of it in 2006. In the case of value vs. growth, the five-year value cycle we've been in definitely looks tired to me, especially since the two big value categories (energy and financial services, again) have both played out. So I do feel having a growth orientation to the portfolio is a better call than value. I do think large cap will outperform small but believe there will be good opportunities throughout the spectrum. That leads to a question: How would you sum up your own investment strategy and how you pick stocks? Well, the best way to sum up how we pick stocks is to discuss the proprietary valuation models we use in our money-management program, which focuses on profitable, well-capitalized companies, and we decide whether they're attractive based on multiples of free cash flow, enterprise value, and long-term growth rates. Ultimately, the ability of a company to generate free cash flow beyond investment determines its ultimate valuation, and it allows you to not only set a buy range for a stock but also a sell range that supplies some discipline. Happily, we're in an era where companies are indeed focused on profitability and generating cash flow, and being judicious on how that cash is used. So I predict an increase in dividends, stock buybacks, and targeted acquisitions. These are the kinds of companies one should accumulate in their portfolios. Many of the names I mentioned earlier are in our portfolios today. Are there any financial stocks you see as plausible picks now? I would say some of the large money-center banks like Citigroup (C ) and JPMorgan Chase (JPM ) will have their day. I'm also bullish on Merrill Lynch (MER ), Goldman Sachs (GS ), and some others. Insurance will do well -- Allstate (ALL ), Prudential (PRU ), American International Group (AIG ). The problem for the smaller banks is that their multiples are high, their earnings growth is slowing, and their stocks may move sideways for some time. Do you have any views on how an investor should allocate assets these days? I do. For a growth-oriented investor, we would have 25% in income and defensive asset classes, with 12% of the 25% in short-term Treasuries, 8% of the 25% in corporate bonds (intermediate term), and 5% in gold. We would have 75% in equities in growth categories, with 62% in the U.S., 13% in foreign, and two-thirds of the equities in large cap, one-third in mid --- and approximately a 60/40 weighting, growth vs. value. Looking at the 13% allocated to foreign, two-thirds in emerging, one-third in developed, and of that one-third, mainly Japan and Europe. For the 5% of a portfolio in gold, would you like it in the metal itself or in gold stocks? If the latter, which one or ones? We own it through the ETF iShares COMEX Gold Trust (IAU ), which is direct ownership of gold that gives us a pure play on the price of gold. Interestingly enough, part of the reason gold prices are moving higher is that producers have run into higher costs and no increased production, so you have some volatility in the business of gold mining that I would rather avoid, and just outright own the metal. Which sectors (or stocks) would you advise investors to avoid for the next year? "Avoid" is a pretty harsh word to use, since there can always be stocks in a group that run counter to trend. But I would clearly underweight energy, consumer discretionary, and utilities, since we're in the middle innings of the economic expansion and interest rates aren't going to be materially lower. Some of the expectations for stocks in this group aren't going to be met. If I expect these stocks to underperform, I would rather be invested elsewhere.
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