The Appeal of a Resilient Market


For the time being, stock prices will be driven by earnings news, says Steve Biggar, U.S. research director for Standard & Poor's Equity Research Services. Though the latest reports have been mixed, Biggar believes positive economic conditions are in place to help push the market higher.

"Our market outlook recently became more bullish after the market's resilience following the London news, fewer than expected negative second-quarter pre-announcements, tamer inflation, a favorable employment-growth picture, and the market's ability to handle $60 oil," he says.

In terms of sectors, Biggar says S&P favors consumer discretionary and technology. Given the upbeat outlook for consumer spending, S&P's top-ranked stocks include home builders such as Lennar (LEN) and Beazer Homes (BZH), along with retailers such as Payless Shoe Source (PSS), Petco Animal Supplies (PETC), and Abercrombie & Fitch (ANF).

S&P's favorite tech stocks include PC maker Dell (DELL), storage provider EMC (EMC), semiconductor-equipment maker Lam Research (LRCX), chipmaker Cree (CREE), and software maker McAfee (MFE).

S&P recently downgraded the energy sector, the best-performing group so far this year, but still likes outfits such as ConocoPhillips (COP), Nabors Industries (NBR), Global Santa Fe (GSF), and Baker Hughes (BHI).

These were a few points Biggar made in an investing chat, presented on July 26 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Karyn McCormack. Edited excerpts follow. AOL subscribers can find a full transcript at aol.businessweek.com/chat.

Note: Steve Biggar is an S&P Equity Research analyst. He has no ownership interest in or affiliation with any of the companies under discussion in this chat. All of the views expressed in this chat accurately reflect the analysts' personal views regarding any and all of the subject securities or issuers. No part of the analysts' compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this chat.

For required disclosure information and price charts for all S&P STARS-ranked companies, go to spsecurities.com and click on "Investment Research" and then on "Required Disclosures & Standard & Poor's STARS vs.Closing Prices Charts."

Q: Steve, tell us your overall outlook for the stock market. Do you think the indexes can break out of these recent ranges?

A: I think the direction of the market for the near term will be dictated by the earnings season. And thus far it has been a very mixed quarter. We do believe that the positive economic fundamentals in place will enable the market to move higher.

Q: What sectors do you like?

A: We're currently overweight on consumer discretionary and technology. For consumer discretionary, a continuation of favorable consumer spending and a recent uptick in consumer confidence will lead to positive performance for those stocks.

Although we expect continued weakness in the auto subsector, our market outlook recently became more bullish after the market's resilience following the London news, fewer than expected negative second-quarter pre-announcements, tamer inflation, a favorable employment growth picture, and the market's ability to handle $60 oil.

Q: What are some of S&P's favorite stocks in the consumer-discretionary sector?

A: In consumer discretionary, we continue to like several home builders, such as Lennar (LEN) and Beazer Homes (BZH). Among retailers, we like Payless Shoe Source (PSS), Petco Animal Supplies (PETC), Abercrombie & Fitch (ANF), and Fortune Brands (FO).

Q: Tech in general has reported mixed earnings lately. What's your recommendation for the sector?

A: Within technology, we like Dell (DELL) in computer hardware, EMC (EMC) in computer storage, Lam Research (LRCX) in semiconductor equipment, Cree (CREE) in semiconductors, and McAfee (MFE) in the software area.

I agree that technology earnings so far have been mixed, but we do see year-over-year operating earnings increases of 16% in 2005 and 17% in 2006. So with a continued strong job market keeping the unemployment rate near 5%, we see an increased need for companies to add to technology at the workplace. History shows that capital spending in general and technology spending in particular usually increase when capacity utilization rises above 80%.

Q: Do you think that Motorola (MOT) stock will advance in the short term due to their recent product introductions?

A: We have a buy recommendation on Motorola. There were recently favorable comments on its new handset products and better competitiveness against wireless peers. We believe their challenge is being a wireless innovator with high-end mobile devices. We also see the relationship with Apple (AAPL) for delivery of iTunes as another source of growth. They are also on track for WiMax and other wireless broadband networks.

Q: Of all the big pharma choices, do you like Wyeth (WYE), and will it hit $50 by yearend?

A: We currently have a hold on Wyeth. Second-quarter earnings were 18% higher than a year earlier. Revenue growth was helped by favorable international sales. We did raise our 2005 estimate to $2.88. We like Wyeth's improving pipeline but remain concerned over their uncapped diet drug liabilities. Our 12-month target price is $47, or a little over 15 times our 2006 estimate of $3.05.

Q: What's your opinion on the future of stem-cell research in the U.S.?

A: Stem-cell research appears to be much more of a political football and difficult to call in terms of an investment recommendation (or how to play it). In the biotechnology space, we're favorable on Genentech (DNA), Invitrogen (IVGN), Charles River Labs (CRL), and Renovis (RNVS).

Q: Any thoughts on Xcel Energy (XEL)?

A: Xcel Energy, which provides electricity and natural gas, was recently downgraded to hold from buy. This occurred after a strong price rise. We think the earnings outlook beyond 2006 will depend on a few yet-to-be-filed rate cases. Xcel plans a large investment in utility assets through 2009 and expects rate-based increases of between 4% and 7% per year. But at $19, we view the shares as fairly valued.

Q: What's S&P's take on energy stocks?

A: Energy is by far the best-performing sector so far in 2005, and we have been overweight for most of this year. However, after this price rise and what we expect to be a leveling-off in the price of oil, we have moved the sector recommendation to market weight.

In the energy space, we continue to like ConocoPhillips (COP), Nabors Industries (NBR), Global Santa Fe (GSF), and Baker Hughes (BHI).

Q: Do you think Cytyc (CYTC) is a buy?

A: We have a buy recommendation on Cytyc, which is a women's health company. We see sales of new products increasing in importance. We have a 12-month target price of $26. This is a modest pe-to-growth-ratio discount. We feel this is warranted by some 2006 uncertainties.

Q: Small caps have been on a roll for a while, beating larger stocks. Do you think smaller stocks will keep outperforming?

A: Some stats to go along with that. So far this year the S&P 500 Index is up 1.8%, the Mid-Cap 400 Index is up 7.9%, and the Small-Cap 600 Index is up 6.9%.

Given our view of higher interest rates and a decelerating earnings growth picture, we do believe the market will begin to favor large-cap issues more. Large-cap issues tend to do better in that environment.

Q: What's S&P's take on China's decision to delink its currency to the U.S. dollar?

A: Overall, we believe the removal of the dollar pegged to the yuan is a positive thing, as it addresses an imbalance. Positives include trimming the U.S. trade gap with China in the longer term, improving the competitiveness of U.S. goods, and ending the tide of U.S. job losses overseas.

Some negatives include raising the costs of Chinese imports and possibly higher gold prices. In any case, we don't believe that the economic effect from even a 5% adjustment will be that great.


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