A Long View of the Market


"The market just has not been acting well." That's the judgment of Arnie Kaufman, editor-in-chief of Standard & Poor's newsletter, The Outlook, speaking from the perspective of more than 40 years at S&P and 30-plus editing the widely followed newsletter. Kaufman notes the frequency of late-afternoon pullbacks and the lack of staying power in rallies.

Kaufman, who'll retire soon, made these and many other comments in an investing chat presented on Jan. 21 by BusinessWeek Online and Standard & Poor's on America Online, in replying to questions from the audience and from Jack Dierdorff and Karyn McCormack of BW Online. Following are edited excerpts from this chat. A complete transcript of this chat is available from BusinessWeek Online on AOL, keyword: BW Talk.

Q: Arnie, the year started out just dandy, the now the market is having some bobbles. As editor of The Outlook, what's your outlook?

A: Right now the market is being held back by worries about a war in Iraq and other geopolitical concerns. But we think that absent a disaster, the market should be up this year by 15% or so.

Q: How low do you think we will get on this down leg? Does it worry you?

A: It does worry me. The market just has not been acting well. Late-afternoon pullbacks, no staying power on rallies. The point that I'm watching closely is 860 on the S&P 500 -- that represents a 50% retracement of the recent advance. If the market breaks through that level, we're likely to see a test of the lows. But my feeling is that if January ends without some development related to Iraq, then the market may move back up to the higher end of the recent range.

Q: Your opinion on the future growth of the Baby Bells, and the telecom sector overall?

A: The Baby Bells are facing some serious problems, and it's going to take a while for these problems to work out. Our view of the Baby Bells is neutral to negative. For the telecom sector as a whole, we are recommending an underweighted position. Over the longer term, when some of the uncertainties are resolved and things are sorted out, the survivors should do reasonably well, but there are better opportunities just now.

Q: What will the high-tech sector do this year? Any thoughts on Intel (INTC)?

A: The tech sector is likely to come out of the doldrums later this year. At this point, we think that the group should be less than market-weighted. There have been a number of recent disappointments -- not so much in the actual earnings figures, but in the comments that have accompanied the earnings news. That holds true for Intel, which is currently ranked 3-STARS (hold) by S&P analysts, meaning its outlook is neutral. But as the conditions in the chip area improve, probably later this year, Intel should do quite well.

Q: When do you think the corporate earnings picture will brighten?

A: Corporate earnings are actually moving up, but much of the improvement is coming from cost-cutting. The top line is still growing slowly. We're expecting GDP to pick up in the second half of this year, with a growth rate of about 4% in the third and fourth quarters, helped by the fiscal stimulus program out of Washington, which we're counting on to be effective around midyear. The pickup in the economy is likely to flow through to corporate earnings and produce a gain in operating profits on the S&P 500 of somewhere between 15% and 20% this year.

Q: What do you think about utilities?

A: Utilities don't look all that great to us now. We're suggesting that they be market-weighted at best. Utilities have surprised people with a pretty good move upward this year, and they would probably need a rest, but with utilities you would be well advised to look at each company independently rather than making a groupwide assessment.

Q: Any thoughts on the energy sector?

A: ...We're overweighting energy at S&P. Our favorites at this time are in the gas area, as we see diminishing supplies and low inventories putting upward pressure on prices and dictating a high level of drilling. The stocks we like in that group are Apache (APA), EOG Resources (EOG), and Nabors Industries (NBR).

Q: What sectors will lead the market in 2003?

A: I think the energy sector is one. Consumer discretionary is another. And consumer staples is a third. I mentioned the S&P choices in the energy sector before -- in addition to those, we like Evergreen Resources (EVG), Exxon Mobil (XOM), and Total Fina Elf (TOT).

In the consumer staples area, we favor a number of packaged-foods companies, which benefit from their defensive nature in a still uncertain earnings environment. Some of the companies we like in this sector are Dean Foods (DF), Kraft Foods (KFT), Smucker (SJM), Tyson Foods (TSN), and Sysco (SYY).

In the consumer discretionary area, our favorites are companies like Applebee's (APPB), Chico's FAS (CHS), Mohawk Industries (MHK), P.F. Chang's China Bistro (PFCB), and SCP Pool (POOL).

Q: Arnie, we hear you're retiring after more than 40 years at S&P. Please share with us some of your best moments covering the markets.

A: That's a difficult one, because there have been many, as well as many disappointments. But I think the most exciting time was the beginning of the bull market in August, 1982 -- Friday, Aug. 13, to be more specific. The market took off like a rocket, with huge gains on an almost daily basis and the promise of the end to a long and difficult eight or nine years for the market.

Q: What are the biggest market changes you have seen?

A: One of the biggest changes was the growing popularity of stocks among individual investors, whereby stock ownership spread through IRAs and 401(k)s to so many individuals. Unfortunately, the last three years have probably thinned the ranks of individual investors. But I expect that will reverse once again.

Another major change was the disfavor into which dividends fell. I clearly remember when stocks averaged yields of 5%, 6%, 7% or more in contrast to the current 1.7% yields on the S&P 500. Much of the change is due to the sharp advance in stock prices in recent years, prior to March, 2000. But in addition, companies took it upon themselves to choose for investors what should be done with their profits, rather than pay them out in dividends.... I expect that some dividend tax relief will be seen, and more companies will begin paying dividends, and that those that already do will start increasing them.

Q: One of the favorite features of The Outlook was your "Stocks to Avoid" list -- can you name the dogs for 2003?

A: Among our current 1-STAR stocks, which are the ones we feel can be sold, are BJ's Wholesale Club (BJ), Eastman Kodak (EK), Campbell Soup (CPB), St. Paul Companies (SPC), Lockheed Martin (LMT), Applied Materials (AMAT), BellSouth (BLS), and Tektronix (TEK).


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