Iraq, China, Terrorism on the Horizon
Investors track flows as a counterintuitive signal for next year's hot sectors. But this carries risks.
Dagen also weighs in on when to sell a stock and why JDS Uniphase will never see 1999 levels again.
The Economy GrowsWith one party in power in Washington, it's going to be a lot easier to pass tax cuts and spending hikes. These are the missing pieces in an economic stimulus package that so far has mainly included lowering interest rates and pushing down the value of the dollar (which boosts domestic manufacturing). More importantly, we are moving toward a presidential campaign. You can bet the party in power will be doing all it can to stoke the economy to win votes. During the past century, similar antics have contributed to stock gains of 12% on average in the third year of the presidential cycle. Republicans seem to play this game better than Democrats. On average, when Republicans held the White House, the S&P 500 has advanced 22% the year after a midterm election. Given how much companies have cut costs during the slump, any improvement should drop right to the bottom line. "I think the economy is going to do a lot better, and if the economy improves, you get two kickers to the market," says James Paulsen, an economist and chief market strategist at Wells Capital Management. "One, from profits going up, and another from people valuing those profits higher because the pessimism ends." Ken Fisher of Fisher Investments goes one step further, projecting that moves by central banks around the world to lower rates and increase money supplies will bring back a bull market. "I am wildly bullish for next year," he proclaims. "For the first time, we are creating excess global liquidity, and the excess liquidity will eventually work its way around to stocks. I predict the market will be up 35% next year." What's striking about the bullish views you hear these days from Paulsen and most of the money managers contributing to this column is that they come from natural contrarians who have been skeptical about the hopes for stock market rebounds throughout much of the bear market.
Bears Are BaitedBears, of course, will have a field day with all this. But some of the bear arguments are getting a little frayed around the edges. Many bears, for example, still cling to the idea that bear markets following a bubble simply have to last longer than what we've been through. A look back shows we may already have done enough time. If you make a composite chart of four recent bubbles -- in gold and oil in 1980, the Nikkei in 1989 and the S&P 500 in 1929 -- and overlay it onto a recent Nasdaq chart, two striking points emerge, according to Bear Stearns. First, the bear markets that follow bubbles typically bottom and begin to turn up about 2.3 years after the bubble peak. That would be right about now. Next, bubbles tend to pull back by 60% on average. The Nasdaq fell by 77% at its recent lows.
Trader's Market Remains in ForceStill, there's enough fear and doubt out there -- and bears and short-sellers to feed it -- that you can expect this year's wild volatility to continue. (On 44 of the 211 trading days through Oct. 31, the S&P 500 rose or fell by at least 2%.) That means two things: If you are a sharp trader, there will be plenty more opportunity. And if you are staking out long positions, you can afford to be patient and wait for good prices. "Economic growth will come in fits and starts, and that will cause a lot of volatility and anxiety, so you have to be very disciplined," says Robert Rodriguez, a value manager at First Pacific Advisors. Right now, for example, he's holding off on buying much, because of the sharp run since the Oct. 10 lows. A brief war with Iraq will probably have the following effect, if history is a guide, says Prudential analyst Ed Keon: The stock market will stay weak and cautious leading up to a conflict, but then move up sharply once uncertainty is gone and victory looks clear.
The Dam May Break in Tech SpendingIf there's one area where spending seems overdue, it's technology. The last major tech binge occurred in the late 1990s, and a lot of the PCs, servers, networking gear and software bought back then are aging ungracefully and starting to eat into productivity. In short, companies risk losing their competitive edge unless they upgrade, and that should start happening next year, says Rodriguez. "I have gotten a lot of debate on that because things are so negative in the tech arena, but we think it will start to gain traction next year." Roger McNamee, a partner at tech investment company Integral Capital Partners, says some recent polls of corporate finance chiefs show confidence is picking up. "That is a huge deal for tech spending," he says. "We will see a gradual increase in technology budgets over the next 20 months." McNamee thinks the best plays are tech suppliers who aren't too diversified, and whose goods have distinct product cycles. One example: Web software company BEA Systems ( BEAS). Many of the riskier tech stocks in areas like telecom equipment, of course, have already snapped back nicely since early October. That's why value manager John Buckingham of the ( VALUX) Al Frank Fund favors the "safer" tech stocks. In this case, the safe techs are the ones with strong financials that haven't advanced 200%; in fact, unlike more risky issues, they never got crushed in the first place. One example is Apple Computer ( AAPL), which has $12 per share in cash and no debt. It trades at around $14 per share, which means you can buy the business for $2 per share. Others include 3Com ( COMS), Compuware ( CPWR) and Kemet ( KEM). He also likes semiconductor stocks that haven't moved as much as the group itself -- stocks like Credence Systems ( CMOS) or Integrated Silicon Solution ( ISSI). "These companies won't appreciate 100%, but they will certainly enjoy their day in the sun," Buckingham says. Some words of caution on tech. Given the bounce since early October lows, a bigger correction could be in store (even beyond the December pullback). And remember, the late 1990s aren't coming back next year.