"Don't Fight the Tape"


"We are in a bull market -- period." So says Michael K. Farr, president of investment firm Farr, Miller & Washington, pointing to a strengthening economy, improved corporate earnings, and increased capital spending as supports for the upward movement. He notes that in the last 12 months, the Nasdaq has risen 72% and the Dow Jones 36%. One note of caution from Farr, however: The market has had no serious setback since March -- a pattern he describes as an aberration.

These were among the comments Farr made in an investing chat presented Oct. 9 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff and Karyn McCormack. Following are edited excerpts from this chat. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Q: Michael, are you as upbeat about stocks as investors seem to have been most of the last several days?

A: Cautiously. I see good news and bad news. The bad news is that this market advance has been without correction, setback, or retracement since March. Historically, any investors with years of experience will tell you that this sort of an advance without pause is an aberration.

The good news is that the economy is recovering, information-technology spending is recovering, capital expenditure is showing signs of recovery, unemployment seems to have hit something of a floor (which may not hold, but any floor is encouraging), interest rates remain very low, and I think that there is a great deal about which investors should be encouraged. Most important, the trend is positive. Markets are advancing. Old investors have a saying, "Don't fight the tape."

Q: I am a senior with several hundred thousand in cash and a very substantial amount in equities (75%). I seek income -- recommendations?

A: Finding income in this market is a real challenge. Recently, we've looked at some preferred stocks for those clients who are in more desperate need of income. They are not a favored asset class of ours but meet an expedient need. One rule for every income investor: Never speculate for income, or speculate with that portion of your portfolio that needs to be safe. High-yielding REITs [real estate investment trusts], stocks, and bonds are high-yielding because they are higher-risk.

Q: What kind of stocks -- and strategy -- would you be looking for in the current market? Any specific names?

A: I think, first and foremost, that the most significant indicator of stock performance over time is earnings growth. Find companies with strong earnings growth at reasonable valuations. That's what we always try to do. Some stocks that I like now are General Electric (GE), Gannett (GCI), United Technologies (UTX), Staples (SPLS), Kohl's Stores (KSS), PepsiCo (PEP), CVS (CVS), Walgreen (WAG), Wendy's (WEN), Pfizer (PFE), and Johnson & Johnson (JNJ).

Others are: Waters (WAT), First Data (FDC), some Microsoft (MSFT), Nokia (NOK), Citigroup (C), Bank of America (BA), Freddie Mac (FRE), American International Group (AIG), and Travelers Insurance (TAP). While we may be buying or selling those stocks in our portfolios, these are not actual recommendations to buy or sell. Don't buy any without researching them yourselves.

Q: Do any bonds seem attractive to you?

A: No. The reason is this: Historical yields are still near all-time lows. When yields increase, bond prices drop, so the money that is invested in bonds that needs to be safe and secure is at risk in a rising-rate environment. We think that the 4% or 5% that can be earned in intermediate corporate bonds is insufficient compensation vs. the risk of higher interest rates. We really prefer to keep our bond investments short and liquid.

Q: What are some of the stocks you like that pay high dividends?

A: Bank of America would be one of my leading plays there, with a 4% dividend. Shares are going at 11 times estimates, with earnings growing at 9%. That 4% dividend makes those shares very attractive. Travelers has a 2% dividend, Citigroup has a 2.9%. Wells Fargo (WFC) is 3.3%. Merck (MRK) has a 3% dividend. Pfizer is 2% (PFE), Kimberly-Clark (KMB) is 2.5%, GE is 2.5%, which is a compelling value at these levels.

Q: Where is AOL headed?

A: AOL suffers from an identity crisis. Time Warner (AOL) is one of the great publishing media giants in the world and a consistent earner that suffered greatly as a result of the AOL merger. The AOL portion of Time Warner has struggled with decreasing subscriptions, poor advertising, etc. An economic recovery should see a rebound in advertising that will benefit Time Warner. Ultimately, you're not paying a lot for these shares at these levels, though it is not an investment for those with weak stomachs. Long-term, we think that the shares will do well.

Q: Beyond AOL, do you like anything in Internet services or software?

A: Most of the stocks in the tech sector have led the market's advance and are on the expensive side of their trading ranges. My Internet stock would be Cisco (CSCO), not without risk. In software, Microsoft.

Q: I would like to know what stocks are you buying now. Any new positions that you're excited about?

A: Well, I'd say that Bank of America is probably my strongest pick right now. Nokia is a new name for us, and I think that prospects are encouraging and exciting. Gannett is a new name that would benefit from economic recovery. GE will benefit long-term and has a good dividend. In general, most public companies are as well positioned as they have been in several years to bring the greatest percentage of revenue to the bottom line.

The strengthening economy, growing corporate earnings, and increasing capital spending support a positive view. The Nasdaq is up 72% in the past 12 months, the Dow Jones is up 36%. Therefore, we are in a bull market -- period. While we have no idea of the heights to which the bull may climb, right now the greatest risk to investors would be to not be invested.


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