For answers on where the economy is headed and which sectors and stocks are poised for growth, Daily Interview turned to Stephen Leeb, editor of the popular financial newsletter Personal Finance and president of Leeb Capital Management.
Leeb predicted the downturn of the technology sector in his 1999 book,
Defying the Market: Profiting in the Turbulent Post-Technology Market Boom and accurately predicted the market boom of the 1990s in his 1986 book,
Getting In on the Ground Floor. Leeb is portfolio manager of
(MEGAX Quote)MegaTrends, a tiny mutual fund that aims to profit from upcoming economic and societal trends; it has returned an average of 13.29% over the past five years.
Leeb thinks the
S&P 500 will rise 20% by year-end, but he also believes the market will continue to be turbulent for the next five to 10 years. And he has very disappointing news for investors still holding out for the revival of the tech sector. That isn't going to happen, Leeb says, arguing instead that financial, health care, utility and energy stocks are going to be where the hottest action is at.
TSC: Running a fund called MegaTrends is certainly a big task to live up to. What are some of the major economic trends you now foresee on the horizon? Leeb: First, we see a mandate for economic growth. That's the biggest megatrend that we are focusing on. We think that recession, or more precisely an economic decline that begins to feed on itself, is a potential catastrophe that most of the central bankers around the world recognize and are willing to do whatever it takes to avoid. There is a compelling need to keep the economies of the world growing.
The reason we are at such risk today is because we consumers and businesses have record leverage, record debt. We have a very interdependent economy to an extent we have never seen before. Equally important, we have a great dependence on financial assets, which means that a decline in financial assets puts a vicious cycle in motion where consumers cut back on spending and that affects the markets and then consumers cut back even further.
Therefore, we have felt for some time that any sign of economic weakness will be greeted by an all-out assault. And by and large, we think central bankers will be successful. We have had near-record cuts in fed funds and short-term interest rates in 1998 and 2001, leading to monetary conditions that are now exceedingly bullish. There is enough money in the economy to counter the effects of the decline in the stock market, and more than that, to provide economic growth.
Second, sooner or later this growth is going to be accompanied by inflation, and I think we are at an inflection point now. Certainly, energy is a big part of this chronic inflationary megatrend we see on the horizon. Natural gas and oil prices have come down, but over the long term, there just isn't enough of these resources, which puts incredible pressure to drive their prices up.
TSC: Where do you expect the major stock indices to move this year? Leeb: To say that the market is going to go up another 20%, 25%, isn't heroic under the monetary conditions we have now: rapid money supply growth, a dramatic drop in short-term interest rates and a widening spread between long- and short-term interest rates. We have only seen the combination of these three monetary factors five times in the last 40 years, and every time we have seen this confluence, the market has risen at least 19% in the ensuing 12 months.
I don't think that's a heroic call, because a 19% gain in the S&P 500 would take us back to our old highs. But as strongly as I feel about that, I feel equally strongly that we are not going to go bursting through those highs. The bull market is over, and we are now headed for a very long-term, turbulent trading market. The cap on the market will be rising inflation and valuations, and the bottom on the market will be this compelling need for growth.
There will be a lot of oscillation for the next five to 10 years. A lot of money will be made, but it will also be very easy to lose a lot of money.
TSC: So how can an investor make money in such a turbulent economy? Leeb: They should take the approach that worked in the year 2000, when a well-balanced, diversified portfolio offering growth at reasonable prices worked. The MegaTrends fund delivered a 16.7% return that year. We are up a little bit this year, too, nearly 3%, following the same approach. It's nothing heroic. We are just staying away from things that would be punished from high inflation -- namely high-multiple stocks, or stocks whose multiples are out of whack with their growth prospects.
It's going to be very similar to the period '76 to '82, when the market went up and down, up and down. If you were in the big-cap, high-multiple growth stocks during that era, you got killed, facing near-term losses of as much as 50%. Yet during that time, some sectors of the economy, including small-cap stocks, rose 24% a year.
TSC: One of your predictions is going to rankle our readers in particular, that technology is headed for a prolonged downturn. Why don't you see a resurgence of an area of the economy that has been one of its biggest drivers? Leeb: These technologies are as much the problem as they are the cure for our problems. Technologies use a tremendous amount of energy. They aren't really geared for solving any major societal problems. What do these companies have to do with solving our energy problem, or with our shortage of natural resources? We can't run this world without energy.
Technologies are the cart before the horse. It's wonderful to have all these whiz-bang gadgets if you know what to do with them. Gadgets for the sake of gadgets, which I think a lot of this computer technology is, isn't going to help you. Does a
Cisco(CSCO Quote) router help cure an energy problem? No. On that premise, it's not surprising that these tech stocks fell. They just are not the answer. They just were not coming up with products that were going to be useful in the long term.
TSC: Are there any technology stocks that you do like? Leeb: Yes, there
are some technology stocks that we still like. In fact, we have an 11% weighting -- a fairly heavy weighting -- in tech stocks, but not because these companies have whiz-bang products that are going to solve the world's problems.
If you believe, as I do, that growth is a necessity in the economy and that it will be accompanied by inflation, then virtually any company with a franchise-like position -- meaning that is has some control over the pricing of their products because they are market leaders -- will continue to do well, no matter what industry group it is in. We look for companies within the tech group that we think are going to grow, that have pricing power and reasonable valuations.
We like none other than
AOL Time Warner(AOL Quote). It's one of our biggest positions because it is a franchise. They have control over their destiny and will probably continue to grow 30% a year.
Also,
Tyco(TYC Quote). Again, they are a leader in a lot of different technology products, including connectors, probably growing 15% a year, selling at 15 times earnings.
Perkinelmer(PKI Quote) is a wonderfully diversified company in biotechnologies, in defense products, growing 15%, 17% a year.
Intel(INTC Quote). I've been recommending Intel in my newsletter,
Personal Finance, since the early 1980s. It's a total franchise. I do think technologies in semiconductors will have a role to play in this world. I'm not a technophobe by any stretch of the imagination. I just think we have to find the right role for them. But for Intel to put up a fabrication plant would cost them $2 billion. Not too many companies have that kind of money, including
AMD(AMD Quote). I've seen estimates that in 10 years, putting up a semiconductor fabrication plant will cost $50 billion. That's more than building a nuclear power plant. No company is going to have this kind of cash to compete with Intel.
IBM(IBM Quote) we like. Again, it's a franchise. It's the leading Internet service company right now.
We like
WorldCom(WCOM Quote). It's a franchise. And it's a cheap stock.
TSC: What other societal trends do you see that lead you to investments? For instance, your fund has heavy weightings in financial, energy, utility and health care stocks. Can you explain why? Leeb: Energy, for obvious reasons, because we think we are in a chronic energy shortage, and any company that is producing, or drilling or distributing energy utilities like
Duke Energy(DUK Quote) or
Exelon(EXC Quote) -- are going to be in very good positions. This is one of the most important megatrends around.
Health care is a group we like because what's not to like? We're all getting older. The median age in this country started rising in 1970 and will continue to rise through 2030. As we get older, we need more drugs. Not only do companies like
Pfizer(PFE Quote) have a bunch of drugs but they are also incredibly good marketers. The drug industry spends $10,000 a year to market to each doctor in this country.
Among smaller pharmaceuticals, we like
Elan(ELAN Quote). We also like
Cardinal Health(CAH Quote). We also like
Quest Diagnostics(DGX Quote), if you want a stake in biotechnology. They do a lot of genetic testing.
Financials are a broad group in and of themselves. We like major banks on the grounds that in this world, no matter what happens, you are still going to need banks as middlemen. We like
Citigroup(C Quote) and we like
J.P. Morgan(JPM Quote). Both are inexpensive and they are absolutely vital to the world's economy.
We also like the well-capitalized property and casualty insurance group a whole lot. Relative to the market, their valuations have been declining for 30 years. That could be reversing itself. Many of these stocks' earnings are growing 20%, 25%, and the stocks are still trading at 10 or 12 times earnings.
Also, the stock and bond markets going forward are not going to be as friendly. How in the world, you might ask, will this help property and casualty companies that own a lot of stocks and bonds? Because their capital won't be growing very rapidly, they will increase their premiums. Also, as environmental damages increase around the world, this also reduces capital from the industry and gives them a reason to increase premiums.
