"We Are Fairly Close to a Bottom"


Even if the stock market falls further, the drop is likely to be less dramatic than that already recorded -- and value-seekers may soon be coming back in to play. So says David J. Braverman, senior investment officer for Standard & Poor's Equity Investor Services.

S&P recommends overweighting the consumer discretionary, consumer staples, energy, and materials sectors, according to Braverman. The emphasis is on the consumer, due to continued strong purchasing. Typical consumer stocks that S&P ranks as buys include Chico's FAS, Costco, and Kraft Foods. Citigroup and FedEx also get its highest marks.

Asked about WorldCom, Braverman points out that S&P dropped the battered telecom from its 500-stock index in May, 2002, and was criticized at the time for doing so. It no longer covers the stock. On another stock currently in the news, he speaks favorably of Pfizer's proposed merger with Pharmacia, partly because of Pfizer's good record in integrating acquisitions.

Braverman made these and many more comments in a chat on July 16 presented by BusinessWeek Online and Standard & Poor's on America Online. He was responding to questions from the audience and BW Online's Jack Dierdorff. Edited excerpts follow. A full transcript is available from BW Online on AOL at keyword: BW Talk.

Q: David, both Bush and Greenspan have tried to reassure us, to little effect. What will stop this slide? Your take on what is causing this great downslide.

A: It's a combination of a few things. First and foremost, investors have realized that stocks were very generously valued a while back. Part of the catalyst for this realization was a lack of confidence in the level of earnings.

What I mean by that is, given some of the accounting scandals and a general slowdown in the economy, people don't have a good way of estimating what the future growth of individual companies will be, and don't have a good way of estimating even the current level of earnings. So investors have moved to the sidelines and reduced their stock holdings. What you see is the result of all of that.

Q: What do S&P's technical analysts say? Mark Arbeter told us a couple of weeks ago to worry if the S&P 500 went below 950, and today it closed at 900.94. I've heard an analyst say there isn't any support in the market until [the Dow] gets to about 8000. What is your thinking?

A: That may be correct, but you have to be pretty impressed with the market's ability to bounce back yesterday. And it looked then like the market was near a selling climax.

What I think will happen now -- and today's action is a bit of a confirmation of that -- is that the market will go and test those severe intraday lows. I suspect that that test will be unsuccessful, and we may go down a bit further, but we are getting to the point, I think, where value-seekers will come in and start buying. So even if we fall further, I don't think it will be as dramatic as what we've already seen.

Q: What is your feeling on WorldCom (WCOME) -- buy, sell, or hold?

A: We have dropped coverage on WorldCom. It's interesting to note that we took WCOME out of the S&P 500 in mid-May, before much of the decline occurred. S&P was criticized in May, but I think, given the subsequent events, it was the right decision.

Q: The CEO confirmation [of corporate financial reports] date of Aug. 14 -- do you think this will affect investor confidence?

A: I think it will help, but I don't think it goes far enough. I think in order to restore confidence, companies are going to have to change their accounting practices, either voluntarily or through mandate. And what I mean is that companies are going to have to expense stock options, are going to have to stop claiming pension income, and are going to have to recognize revenue when it's actually received. Companies are still resistant to some of this, but I think corporate cultures will eventually have to change.

Q: Do you see the Spider as a good but safe long-term investment? Explain SPDRs to us briefly, if you will, David.

A: Spiders, more commonly known as SPDRs, are S&P's depository receipts...basically, an exchange-traded index fund giving the holder ownership in all 500 companies in the S&P 500. It's an inexpensive way to be well-diversified.

The expense ratio is less than 0.2%, making it less expensive than most mutual funds. In addition, this can be traded like a stock at any time during the trading day. You will never outperform the market, but unlike most mutual funds, you won't underperform, either.

Q: What sectors and stocks are likely to lead us out?

A: Right now, we would stress the consumer discretionary area. We would also overweight the consumer staples area, the energy area, and materials. Our reasoning is that low interest rates and lower taxes will keep the consumer spending. We like the staples area, because these companies tend to have large overseas exposure. And the weakness of the dollar helps profit translation.... Overall, we see a gradual recovery for the economy.

Q: What is your opinion on Pfizer (PFE) and its merger with Pharmacia (PHA)?

A: We continue to recommend accumulation of PFE. We think the proposed acquisition is a good one, giving PFE access to a broad product line. PFE has a history of successfully integrating companies, and did a good job with Warner Lambert several years ago.

Q: What about Level 3 (LVLT)? I hear Warren Buffett is interested in this stock.

A: Yes, Berkshire Hathaway (BKR) is part of an investment group making a $500 million investment in Level 3. Warren Buffett, the chairman of Berkshire, has long been interested in Level 3, but was waiting for bargain-basement prices in the telecom industry before committing funds. Walter Scott, the chairman of Level 3, is on Warren's board, and is even the owner of the office building where Berkshire has its headquarters, in Omaha. I don't expect that this will grow to be a huge portion of Berkshire Hathaway. I think it's simply an opportunistic investment on Buffett's part.

Q: Does S&P rank LVLT?

A: We are currently neutral on Level 3, mainly because the company still has negative operating cash flow. One might consider the company's bonds before making a commitment to the stock.

Q: What bottom number do you see for the Dow? Or the S&P 500? One audience member chimes in with 2,200 for the Dow!

A: Well, I doubt that Jack and I will be doing many more chats if the Dow reaches 2,200! I think we are fairly close to a bottom now. I think that you could argue that...in a worst case, the market might assign a price-earnings ratio of 15 to [the S&P 500], giving a rock-bottom valuation of 750. That's roughly a 17% decline from current levels. I don't think it will get any worse than that, and I would be surprised if it were even that bad.

Q: Here's one about two quite different stocks: What is your opinion of Home Depot (HD) and Juniper Networks (JNPR)?

A: We have an accumulate recommendation on Home Depot, which follows our belief that consumer spending will remain strong. The housing market has been particularly strong over the past year, and we think HD should benefit from that.

We are neutral on Juniper. Last week, JNPR posted breakeven results for the second quarter, slightly ahead of Street expectations. We expect a loss for the full year, but the company has a strong balance sheet, which supports our neutral recommendation.

Q: GE meets numbers they swear by and still rides down. What's up?

A: GE, in our view, also has a quality of earnings issue. They reported a 13% rise in reported second-quarter EPS. But our core earnings measure [S&P's new criteria for figuring corporate earnings], which adds the cost of stock options and eliminates pension income, reduces the rise in core EPS to only 5.5%. Moreover, second-quarter operating cash flow actually fell 2.8%. We would not get overly excited about buying GE stock at prices above $25. For now, we remain neutral.

Q: Would you advise that the small investor continue to dollar-cost-average into a market like this?

A: Yes, but only if your time horizon is sufficiently long -- meaning five years or more. My current view is that the market will move higher over the next several years, but may not have made up its low. And the timing is always not what one would have originally expected.

So, if you're saving up to buy a boat in 2003, the stock market is probably not the place for you. But if you have a child who will be going to college in seven or eight years, then go ahead and dollar-cost-average.

Q: What is S&P's ratio of buys to sells now? Approximately?

A: ...We're about three to one in favor of the buys. Out of 1,200 stocks that we follow, we've got about 100 buys [5-STARS in S&P's Stock Appreciation Ranking System] and about 35 sells [1-STAR].

Q: How has the market's fall affected the STARS list? Any interesting changes, especially among the buys?

A: Well, our emphasis now is more on the consumer discretionary stocks -- names such as American Standard (ASD) and Costco Wholesale (COST). The weakness in the market has also led to significantly more sell recommendations, some of which are household names such as Dow Jones (DJ) and Eastman Kodak (EK).

Q: I'd like to know more about the sell list. A stock must be pretty bad to warrant selling into this soft market.

A: There are a lot of stocks that just don't warrant purchase -- and in this environment are not going to recover very quickly. I'd like to point out that S&P has more sell recommendations than anyone else doing stock market research. Last year, a survey by Bulldog Research found that 23% of all sell recommendations came from S&P.

Q: How about Best Buy (BBY): Is it a good value now?

A: We have an accumulate ranking on Best Buy. We think it is continuing its leadership role in electronics retailing, and we see opportunities for the company to boost profits by further shifts to digital products and by new store openings.

Q: Intel (INTC): What do you think?

A: We would avoid the stock. It looks for the time being that PC demand will not be overly strong, and this forces Intel to cut the prices of its chips faster than it might otherwise have done.

Q: Is the drop in the dollar going to affect the market more -- and does that make international mutual funds more attractive?

A: Yes to both questions. For the U.S. markets, a limited drop in the dollar helps profits of U.S. companies with overseas exposure. However, a sustained drop in the dollar causes losses for foreign holders of U.S. stocks, who might be tempted to sell. So a drop can go from being helpful to harmful in quite a hurry. At this point, I would consider buying some international funds, but I'm not sure I would make that more than 20% of a portfolio.

Q: David, can you give us a sampling of the S&P buys at this point? If we can feel confident enough to buy!

A: Some names that we would buy right now include: American Standard (ASD), Boeing (BA), Citigroup (C), Chico's FAS (CHS), Costco (COST), Quest Diagnostics (DGX), FedEx (FDX), Hovnanian (HOV), Kraft Foods (KFT), and Moody's (MCO).


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