"It Looks Better Each Day"


It may be a little early for champagne, but David M. Blitzer, managing director and chief investment strategist for Standard & Poor's Corp., is encouraged by the stock market's recent gains. The market may retest some recent lows, he thinks, but "it looks better each day."

For the economy, however, a couple of sluggish quarters are still ahead, in his view. And it will be close to yearend before technology revives. For now, he notes that S&P recommends stressing the energy, consumer staples, utilities, and basic materials sectors. For overall asset allocation, his suggestion is 65% stocks (which he calls "a tad" above normal), 25% bonds, and 10% cash -- assuming an investment horizon of 5 to 10 years.

Blitzer predicts that the S&P 500-stock index will end the year in positive territory, somewhere around 1,350, and that the Dow Jones industrial average will hit 11,000 again.

These comments came in a chat presented May 1 by BusinessWeek Online and S&P on America Online, in response to questions from the audience and from Jack Dierdorff of BW Online. Edited excerpts from the chat follow. A full transcript is available on AOL at keyword: BW Talk.

Q: David, it was another good day for the stock market. Do you think the market and the economy are bottoming out?

A: Yes. The market has been more encouraging of late. There's still a chance we'll retest some of the recent lows. But it looks better each day. The economy, though, probably has another couple of slow, sluggish quarters to come.

Q: How soon do you see technology turning around? Investment in tech still is very sluggish and layoffs continue.

A: Late this year. The tech sector still has substantial overhang. There was so much overinvestment. And there's probably a lot of used equipment still floating around in the market. We won't see a real improvement on spending on tech and software until the fourth quarter.

Q: So where do you see the S&P 500 index going?

A: This year we expect positive returns. Nothing huge. Maybe single-digit percentage gains. Close of the year between 1,325 and 1,350 on the index. But enough to get us into positive territory.

Q: By historic standards, that's not too bad -- we were spoiled by the late '90s, weren't we?

A: The late '90s was a rare period. The only other time in the 20th century we had five years that did that well was beginning in June, 1932, after the market had fallen 80%.

Q: Would you expect the Dow to reach 12,000 this year?

A: That sounds a little rich. It'll certainly get over 11,000, but I don't think we'll get all the way to 12,000.

Q: Has the tech tumble caused any changes in the 500?

A: There's been a big shift driven by the market, not by the way we run the index. In March of last year, the index was over one-third in tech stocks. Currently, it is less than one-fifth in tech.

Q: Are you expecting Mr. Greenspan's knife to do some more cutting on short-term rates?

A: Yes. We expect another 50-basis-point cut -- probably 25 basis points at the mid-May meeting and another 25 at the end of June.

Q: Is the Total Stock Market Index a better barometer for stocks than the S&P 500? Why or why not?

A: Probably not. The S&P 500 is managed to be a fair index, meaning that investors can actually buy all 500 stocks in the same weighting as the index and get the same results. For example, the Vanguard S&P 500 fund returns come in within a few basis points of the theoretical returns that we calculate for the 500, based on the stock prices of those companies. There is no assurance you can get the Total Market Index results in the real marketplace.

Q: Does an index fund truly beat 80% of the actively managed funds, over, say, a five-year or longer period?

A: In some years in the late '90s, yes. We usually say in a typical year the index funds beat 65% to 70% of the active managers. Over longer periods, the index funds tend to do better, not worse. It's very hard for the active managers to sustain market-beating performance.

Q: With less than 20% of the 500 now in tech, does S&P suggest a similar allocation of that sector in a portfolio?

A: Twenty percent would be a market weighting. In the near term, we might be a little less than that.

Q: Obviously, strategy varies with age and goals and risk tolerance, but what sectors [and allocations] does S&P recommend now?

A: We would suggest being overweighted in energy and consumer staples and also utilities and basic materials. We would be underweighted in capital goods and technology and market-weighted for the rest of the market.

Q: What's S&P's recommendation now on asset allocation -- stocks, bonds, cash?

A: Right now our allocation recommendation is 65% stocks, which we consider just a tad above normal, 25% bonds, and 10% cash. That's for a typical investor with a 5- to 10-year horizon.

Q: What kinds of bonds look best now?

A: ...The Treasury inflation-protection securities yielding 3.25% to 3.5% look attractive. Some of the lower investment-grade corporates also look attractive -- the single-A-rated stuff. Some junk bonds may also be attractive for those investors who have a broker who actually does the research on junk debt.

Q: What foreign markets look most appealing?

A: Right now, probably Europe. Japan is still stuck in a rut. Canada is suffering from the same tech issues as the U.S. Europe had less of a tech bubble. Europe will see better growth than the U.S. this year.

Q: What kinds of situations cause a change in the 500?

A: What would cause a change is principally mergers and acquisitions involving the companies in the index or other corporate actions. Sometimes a company significantly underperforms the market for a long time, and we'll pull it out. But that is pretty rare.

Q: How have the S&P MidCap and SmallCap indexes been doing relative to the large-cap 500?

A: Both last year and year to date this year, the MidCap and SmallCap indexes have done a bit better. From the start of this year, the 500 is down 4%, the MidCap is down 0.5%, and the SmallCap is up 1.25%.

Q: Does that imply for now that investors would do better in the smaller stocks, as some analysts are saying?

A: It suggests that the small-cap effect is working right now. And that small- and medium-sized stocks would probably be more attractive. At the same time, one should recognize that the tech weight is less in the small- and mid-caps than it is in the 500. That might be why the small-cap index looks a little less fearsome right now.

Q: What kind of impact do you expect Bush's tax cut to have?

A: As Greenspan warned, tax cuts come almost too late. They probably won't have much impact till late this year. They'll probably help consumer spending and the economy when they do arrive.

Q: David, you've recently published a book on how indexes can help you beat the pros. How much better can you do?

A: If you follow the suggestions in Outpacing the Pros (I didn't write the title), you would be in one of those index funds that typically outperform 65% of the stock pickers.

If you think you're a good enough stock picker to beat the index, my suggestion would be to put half your money in indexes and half in your picks -- and see which have has a higher return at the end of the year. As I explain in my book, understanding the indexes also helps in picking individual stocks.

Q: Briefly, how does that work?

A: Market measures based on the index like price-earnings ratios or dividend yields or price-to-sales are very useful in identifying undervalued stocks.

Q: What part of the energy sector looks best to S&P now?

A: Oil in general -- and exploration and drilling in particular. These are the companies that stand to benefit from higher crude prices and recent renewed interest in exploration and production.

Q: And utilities look good despite the disasters in California?

A: California utilities might best be described as a special situation. Outside of California, utilities are a sector of the market that we'd overweight.

Q: What's the next indicator to watch for signs of economic improvement? First-quarter gross domestic product was a good start, perhaps.

A: I guess over the next couple of months I would look at the weekly unemployment claims, which have been disappointing recently. And I look at the NAPM reports -- that's the National Association of Purchasing Management.


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