Hot Sectors to Hedge Your High-Tech Bets
I tried, I really did. But I couldn't get a single nontechnology stock into the
And it wasn't just that my voters ignored nontechnology stocks. They scorned them. The inclusion of Target got comments such as "Target? Where's the growth there?" and "That is the sorriest bunch of nominations I've ever seen. Target, the department store, is going to outperform Nortel Networks (NT) or Applied Micro Circuits (AMCC) over the next five years? Are you kidding me?"
I find this both surprising and intriguing.
Still Swinging for the FencesSurprising, because I would have thought that, given how badly many fast-growth, high-price-to-earnings stocks have been punished since March -- including examples in Jubak's Picks -- more investors would have voted for slower growth with less risk. I wouldn't have been surprised if the vote had shown a massive shift away from high-risk and high-tech. But despite the punishment, it seems like a lot of us are still swinging for the fences. Target, which analysts project will increase earnings by 16% in the fiscal year that ends next January, is just not as attractive a proposition to us as Applied Micro Circuits, which analysts expect to grow earnings by 133% in the fiscal year that ends in March 2001. And that's even though Target trades at a trailing 12-month price-to-earnings ratio of just 22, while Applied Micro Circuits trades at a multiple of 383. Intriguing, because I think this reaction bodes well for a fall recovery in many of the highfliers that have taken a pounding this summer. Investors are likely to be somewhat more cautious, asking for real earnings and plausible plans to ramp growth. But it appears from this vote that the core of technology investors, whose support is critical for this group in the future, aren't about to abandon potential winning stocks from the revolutions in wireless communications, optical networking and electronic commerce that are reshaping the economy. The fundamental belief in those trends appears unshaken, and these investors appear willing to pay up to be part of those trends.
Good News for Tech SectorThat's an important indictor to me. Add in the record river of cash that flowed into stock mutual funds in the second quarter -- at $73.4 billion, the highest ever for the period -- and sentiment seems positive to me for the rest of the year. Fundamentals point the same way. Analysts are forecasting earnings-per-share growth of 10% or more for the rest of 2000, and we're about to enter what is traditionally the strongest part of the year for technology revenues and earnings. All in all, I think the battered technology sector is positioned to do much, much better in the last three to four months of the year. That's good news for Jubak's Picks. My entire strategy this year has been built on sticking it out with many of the high-growth, high-multiple stocks in the portfolio until the fall -- and even adding a few names like BroadVision (BVSN) and Atmel (ATML). This will work out quite well for me if these stocks come roaring back the way they did in this same period in 1999. If everything works out, stocks like RF Micro Devices (RFMD) and PMC-Sierra (PMCS) will leave the slower-growing Targets of the stock market in the dust. If this scenario is correct, I think it's pretty clear what an investor ought to be doing. Hold onto those high-growth, high-multiple technology stocks that have shown good relative strength during the technology crunch. Add new positions from among the technology stocks with the best relative strength, using cash raised by selling stocks that didn't come through the downturn in very good shape. (If you'd like to see a more detailed explanation of this strategy, see Jon Markman's Aug. 2 column,
Fine-Tune Your Side BetsIt's hard to figure this "probability of error" into investment decisions. Most of us deal with this issue by a seat-of-the-pants method that we call hedging our bets. To a portfolio of high-growth, high-multiple technology stocks, we'll add a drip of retailers, a drop of financials, a dab of drugs. These sectors have tended to do well in the past when technology stocks have done badly. We can fine-tune this sector selection by studying the recent performance of the market. In the last week or so, for example, when technology stocks have been down, sectors such as regional banks, drugs and oil drilling and services have been up. And comparing a stock's (or a portfolio's) performance in an up market with its performance in a down market is also a useful tool. But I'd like to suggest a way to take this hedging strategy a step further by using a rough what-could-go-wrong analysis to see which sectors actually work best as hedges on a technology-heavy portfolio.
Here's What Could Go WrongOK, so what could go wrong with the technology sector? Let's take two major possibilities. Interest rates could resume their climb after the November election. And the economy could slow enough to hurt earnings. How do those alternate scenarios play out with the sectors we're considering as hedges? Higher interest rates wouldn't be good for any stocks, of course, but they'd be particularly tough on financials. Slow growth in the economy, on the other hand, would probably help financials, since it would mean no more interest-rate hikes. I'd give financials a rating of minus one, plus one. Drugs? Higher interest rates would probably work to the sector's benefit -- as long as the hikes weren't too aggressive -- since investors tend to buy drug stocks as safe havens when the market as a whole gets rocky. If economic growth slows, but again, not too much, the sector could go either way. Traditionally, drug stocks are a haven when growth comes into question. But the drug stocks are so high-priced themselves -- and Pfizer (PFE) recently threw a scare into the sector by posting anemic growth -- that slower growth in the economy is likely to hurt the sector. I'd give drugs a plus one, minus one. Oil? Higher interest rates are not an issue, except for the most leveraged of companies. Slower growth? Not an issue either, as long as we're not talking recession. The price of a barrel of oil is high enough that it could fall substantially without forcing any cutbacks in drilling and exploration schedules. I'd give drilling and services stocks a plus two. So to hedge a technology-heavy portfolio now, my first choice would be oil drilling and service stocks. I dropped Schlumberger (SLB) from Jubak's Picks on July 28 in the belief that we were far enough along in the recovery cycle for this sector to pick a more aggressive stock than this industry leader. My two picks at this point in the cycle would be Ensco International (ESV) and Marine Drilling (MRL). Both are highly leveraged to activity in the Gulf of Mexico, an area that has gone from cold to hot in recent months. I think the potential return from either of these picks is about 35% in a year -- Schlumberger by my calculations was likely to return 15%. Since I've only got one empty slot in Jubak's Picks right now, I'm going to add Marine Drilling, with a target price of 34 in August 2001. My second choice as a hedge would be financial stocks, especially since I think there's a good likelihood that the
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