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The Plunge That Refreshes?
Old Economy stocks are down. Many are also bargains
Just when everyone thought Old Economy stocks could not get any worse, they did. Sky-high oil prices, a Federal Reserve hell-bent on raising rates, and the dramatic Mar. 7 profit-warning by Procter & Gamble Co. sparked a sell-off that carried the Dow Jones industrial average to its lowest point in almost a year. While the Dow is off 14% so far this year and the broader Standard & Poor's 500-stock index is down 7%, the New Economy tech-laden Nasdaq is ahead an awesome 20%.
Is the Old Economy stock market dead? Not by a long shot. "Investors are being presented with the best buying opportunities in a decade. There are many cheap, quality Old Economy businesses that should make a comeback in 12 to 18 months," says David A. Katz of Matrix Asset Advisors Inc.RIPE. Consider this: An eye-popping 70% of all S&P 500 companies have price-earnings ratios of below 20 times 2000 earnings estimates. And sectors such as financials, drug companies, media and advertising, and retailers are ripe for the picking, say analysts.
One reason for a comeback is that some of the negatives for the stock market are largely transitory. Rising oil prices, which can cut into corporate profits, are already beginning to ratchet downward (page 42). What's more, oil's impact on the market may not be as dramatic as many have thought. Although P&G stated that its profit warning was in part caused by rising oil prices, experts contend that the company's woes are due much more to a corporate restructuring. "There was no sense to the magnitude of the sell-off in the stock market in relationship to P&G," says Brian G. Belski, chief investment strategist at George K. Baum & Co.
Also, the Federal Reserve will probably raise interest rates a quarter of a percentage point, to 6%, on Mar. 21 and again in May. But the decline in the market so far this year should temper the need for further increases. And that could give a much-needed boost to interest-rate-sensitive stocks.
But even if rates continue to rise, there are many Old Economy stocks that have strong growth prospects and could weather a high-interest-rate environment. For instance, a growing number of cheap Old Economy companies are using more technology or greatly benefiting from it. Companies across the board are making productivity strides that can offset the increase in borrowing costs. "These are companies that may fall into the value or Old Economy category, but they've got incredibly strong growth components," says Katz.
Where are these gems? Experts say they are in select areas of the Old Economy landscape. Their stocks have been beaten down, but their profits are rising. Take advertising and media companies. "The dot-com's are spending a lot on advertising, so global ad agencies such as Omnicom, Young & Rubicam, and Interpublic Group are starting to benefit," says Thomas M. Galvin, a market strategist at Donaldson, Lufkin & Jenrette Inc. Radio broadcasters and newspapers are also benefiting from increased ad revenue. "I get a hernia when I pick up The Wall Street Journal these days," says Galvin. The newspaper recently reported a 47% increase in ads year-to-date over the same period a year ago.
Another area to look at: pharmaceutical companies such as Bristol-Myers Squibb, American Home Products (page 153), and Abbott Laboratories. "Drug companies have historically had p-e's comparable to those of tech companies. But techs are now selling at a 300% premium to pharmaceuticals," says Katz, who says that if investors can can muddle through the election rhetoric with these stocks, they'll profit. "They've got strong pipelines, and ultimately we believe government won't slow these companies down," he says.ONLINE OOMPH. Then there are brick-and-mortar retailers that are benefiting more from e-commerce: Office Depot Inc. posted $800 million in online sales in the fourth quarter on an annualized basis. And retailers such as Circuit City Stores Inc. and Best Buy Co. are beginning to benefit from the "digitization revolution in electronic products," according to DLJ's Galvin.
There are even good deals to be found among financial stocks. Galvin likes investment bankers and brokers such as Morgan Stanley Dean Witter and Merrill Lynch & Co., both trading at less than 20 times forward earnings. "They're benefiting from areas like asset-gathering and increased mergers and acquisition activity," says Galvin. And Katz likes Freddie Mac, the home lender. "It's less interest-rate-sensitive than most financials and is due for nice earnings increase this year," he says. Finally, Bank of America Corp. is another pick because it is increasing its online services and it's cheap--selling at 10 times forward earnings.
Don't expect Old Economy stocks to pop back to their highs anytime soon. The allure of the technology sector is still out there. But for investors looking for good values, solid earnings, as well as strong long-term growth potential, Old Economy stocks may be the next new thing.By Marcia Vickers in New York, with Michael Arndt in ChicagoReturn to top