GAUGING THE MARKETS
Stock Watchers Predict Markets’ Direction; Where the Smart Money Is Going
By ANDREW SIMONS
What a year it’s been for stocks,and Orange County shares in particular.
In the past year, Orange County’s stock indexes have seen torrid growth. The OC 50 index of companies with market values of $25 million to $1 billion is up 86% in the past 12 months, with the Billion-Dollar Club of OC-based companies with market values greater than $1 billion recording a 91% gain. Outshining them both is OC’s Tech index, up 135% in the period.
OC’s market indexes are tracked by Newport Beach-based Roth Capital Partners LLC.
The county’s stocks stack up well versus the national averages, which include the S & P; 500 index (up 34% in the past 12 months), the Dow Jones Industrial Average (up 33%) and Nasdaq (up 72%).
To be sure, the solid market results come after two years in which billions of dollars in shareholder wealth were obliterated in one of the worst stock downturns in recent history.
While all OC stocks were subject to the major correction, none felt it stronger than tech.
To see the effect, look at Irvine-based Broadcom Corp. The market value of the chipmaker slumped from $60 billion to $6 billion in an eight-month period from 2000 to 2001, erasing sizable wealth from its two founders, Henry Nicholas and Henry Samueli, as well as big paper gains from all its workers.
But the stock market downturn caused another OC name to flourish,that of Newport Beach bond manager Pacific Investment Management Co., or Pimco (see page 52 for Pimco’s outlook on interest rates and the bond market).
Investors, smarting from massive stock losses, moved a great deal of their remaining wealth into bond funds such as Pimco’s Total Return fund, managed by resident guru Bill Gross.
Total Return became the world’s largest managed mutual fund for a period when stock losses continued to mount.
Of course, nothing stays the same for long. Investors slowly began to dip their toes into stocks again last year.
Looking back at Broadcom reveals a hopeful picture for stock investors.
The chipmaker’s market value has rebounded to $9.3 billion with a 200% stock gain in the past 12 months. And analysts, encouraged by more capital outlays by chip-consuming companies and shrewd moves by Broadcom management, are recommending the stock.
But after such impressive gains, can stocks continue to go higher?
Bears say that stocks have gotten a bit ahead of themselves and that the fundamentals don’t justify valuations. Bulls argue that the run-up in stocks is justified by still-low interest rates and improving employment, manufacturing and consumer spending numbers.
To help sort out what’s in store for the markets, the Business Journal asked OC stockbrokers, investment bankers and money managers what they think about the rebound.
Specifically, they were asked: Do you see the stock market rebound continuing? Where will the market be at the end of 2003? Where will the market be at the end of next year? What are some of the key sectors to be investing in over the next couple of years? Is tech back? How are you mixing up your clients’ portfolios,a shift from bonds to stocks, for example?
At recent check, stock market levels were S & P; 500,1,030; DJIA,9,680; and Nasdaq,1,911.
Steve Nielander
Director
Deutsche Bank Private Wealth Management
Costa Mesa
We do see the market rebound continuing. Our view is that the economy is expanding and that corporate earnings are leveraged for a move up with revenue expansion, as there has been a considerable level of expense reduction that has taken place.
While many people still are concerned about the economy because they’ve seen unemployment levels move up versus the past few years, they have to remember that unemployment is well below levels of the early 1990s, during the last recession.
It also is a lagging indicator and, after corporate profits begin to improve, then businesses will begin to expand and hire as they typically do during a recovery.
Our current view is that the year-end S & P; 500 level is expected at 1040, so while only slightly ahead of current levels, it represents a solid return for 2003.
Our current view is that the S & P; will end 2004 at a level of 1160, or about 11.5% higher than 2003’s expected level. With dividends, that should provide an approximate return of 13% for 2004.
We like the financial sector with reasonable valuations and attractive dividend yields.
Many of the stocks in our portfolios in this sector have price/earnings ratios of 11 and under, with dividend yields in the 3% range.
The stocks we like represent a combination of large regional banks like US Bancorp (USB), national companies such as Bank of America (BAC) and global leaders like Citigroup (C).
We also like the healthcare sector, which we believe has favorable demographic conditions for the foreseeable future. In this sector we currently favor some of the medical device companies and specialty healthcare companies as opposed to the large pharmaceuticals that are being impacted by generic competition.
Another sector that we are overweight in is consumer discretionary, as we believe an economic rebound will lead to increased consumer confidence that, in turn, will lead to a pickup in consumer spending.
Technology will continue to be an important part of our client portfolios, as we believe it helps to improve overall economic growth. Considering the solid run in most technology stocks this year, it is important that investors watch valuations that start to get out of line.
While the semiconductor industry typically leads in an economic pickup as it has recently, investors have to be comfortable that the earnings will be in place to support the expanded valuations or they should consider taking some of the profits and reducing their exposure.
We have been moving our client portfolios to the higher end of the targeted equity range for most of this year and would continue to recommend that strategy.
We feel bond yields are low and provide potential risk at this point, so we have portfolio duration below normal levels.
We have been utilizing alternative investments such as selected hedge funds and structured investments where appropriate.
Jim Axelson
First vice president, financial advisor
Merrill Lynch & Co.
Laguna Hills
The major stock market averages have been hovering at their recent highs, bouncing up in reaction to good news and sliding when an unfavorable item crosses the tape.
Jittery moves of that kind mean that investors are waiting for something to come along that gives them a clearer idea of what lies ahead for the economy.
Our economists believe that the labor market is key to understanding when the upturn will become self-sustaining and not have to rely on help from fiscal and economic stimulus.
The economy isn’t likely to grow solidly on its own until the job market firms and stays that way for some time.
Recent data indicate that the economy may have started the fourth quarter on a softer note but that trends are reasonably healthy.
Indeed, the increase in payrolls in September was an unexpected bright spot. The stock market usually anticipates what the economy will do, so as long as the economy keeps rebounding, the market should continue to rise.
Our ultimate targets for the 2003-2004 bull market cycle remain DJIA 10,500 to 11,000; S & P; 1,150 to 1,200; and Nasdaq Composite 2,200 to 2,400.
Looking ahead, it’s important to note that another large dose of stimulus is on the way: The tax cut package that was enacted earlier this year is set to pump $130 billion into the economy during the federal government’s 2004 fiscal year, up from $45 billion in 2003.
If the economy strengthens in the time frame we’ve outlined, it would fit well with the pattern that Dick McCabe, our chief market analyst, thinks the stock market will follow. He expects a pullback in the period immediately ahead to be followed by further advances in the cyclical bull market into 2004.
Our research tells us that an increase in defense spending looks like it is here to stay for the next few years. With our aging population, healthcare and biotechnology look to do well, as do energy investments over the next couple of years.
Technology never went away, but expectations got ahead of themselves. It is technology that is helping our increase in productivity, it is technology companies that have the largest increase in profits and it is technology that is helping many industries like biotechnology and defense with new innovations.
We think that tech stocks look vulnerable on a short-term basis but that they are likely to move higher during the next three-to-five months.
After that, we think that they will be weak in 2004. We continue to suggest that investors equal-weight the sector.
The lesson to be learned over the past few years is to stick to the appropriate asset allocation for each individual’s particular situation.
The key to accumulating and preserving wealth is asset allocation and diversification within asset class, sector and size and style.
Asset allocation and diversification are crucial elements in investing. In fact, various studies show that asset allocation determines 60% to 90% of a portfolio’s performance.
The past few years have given my clients a real view of their risk tolerance, which helps in determining the appropriate asset allocation. If bonds and cash have become too large a portion of a client’s portfolio, we are now adding stocks.
While Merrill Lynch analysts currently recommend an asset allocation of 45% stocks, 45% bonds and 10% cash, every individual should evaluate their situation based on a thorough review of investment goals, time horizon and tolerance for risk.
Individuals also need to properly diversify within asset classes.
Within the equity portion of their portfolio, a client has to decide if they want to invest in small, medium or large capitalization companies.
Equity diversification includes holding stocks from different sectors or industries or with different market capitalizations (such as large- and small-cap stocks) and different styles (such as growth and value).
As always, plan to review your asset allocation with your financial advisor each year, examining your portfolio performance, your personal goals and market conditions. If your goals, time frames or tolerance for risk have changed, you may need to change your asset allocation model.
Mark Stewart
President
Stewart Securities Inc.
Newport Beach
I definitely see the rally continuing. A huge rally on a Friday in early October is really out of character for the month and signals that the worst is over.
If it is, then we are closer to the beginning of a new bull market than the end.
I see the Dow Jones Industrial Average possibly hitting 10,000 by year-end and 12,000 by the end of 2004.
Being selective in the tech sector is where aggressive investors should be for some of their investment dollars, in my opinion. Tech is back and will do even better as capital expenditures picks up when it is more clear we are out of a bear market and companies start to spend again.
The bond market may be the next new upset for investors who think that bonds are a safe haven and quickly discover what happens when rates move up.
If the stock market rally continues, this is the likely scenario. In my estimation, a new bull market is here.
Gordon McBean
Director of research
Roth Capital Partners LLC
Newport Beach
I believe that the rebound in the stock market will continue for the foreseeable future. By the second week of the fourth quarter, we had not seen many warnings from companies regarding third-quarter numbers.
We are also very encouraged by the September employment report, which we feel may turn out to be a pivotal moment in the ongoing economic recovery.
We feel that the market will continue to rise through the fourth quarter, fueled by an improved economic climate. A slightly weaker dollar, continued improvement in employment numbers and the favorable interest rate climate should all help fuel the U.S. markets. We expect to see the S & P; 500 rise a further 2% to 3% by the end of the year.
Next year could be more of the same with continued economic improvement and a further 8% to 12% gain in the S & P; 500.
Aaron Gurewitz
Managing director
Roth CapitalPartners
After a three-year period of shying away from issues, investors’ appetite for public offerings in all sectors appears to be on the rise.
As of early October, there’s a backlog of 58 initial public offerings set to raise $7 billion and 31 follow-on offerings totaling $2.4 billion.
Today’s investors are looking for quality companies with good growth potential, and they’re not limiting interest to companies with profits and strong balance sheets.
There are indications that biotech, technology and even Internet survivors are gearing up for the equity capital markets.
For the past two years, companies weathering the market downturn have been accessing the equity capital markets primarily through PIPEs (private investment in public equity), or accelerated follow-on offerings, with many funds going primarily to meet existing company needs.
In a sign of better times ahead, we’ve seen a shift in funding objective from survival to growth mode, with companies looking to the equity markets as a source of capital to fund growth and expansion.
Similar positive signs are beginning to appear in the Orange County marketplace across all industry sectors.
For the first three quarters of this year, Orange County logged four follow-on offerings, including two real estate investment trusts, totaling $358 million. There were no IPOs.
In a similar period last year, Orange County recorded a total of three transactions that included two shelf takedown follow-ons and one initial public offering.
Total dollars raised for those three companies, including overallotment, was about $200 million.
Though the total number of deals isn’t significantly different, what is encouraging is the performance of the stock.
On average, the four follow-ons completed in the first three quarters of this year have returned about 36% as of Oct. 6 from their offering price.
The three deals completed last year saw a negative 42% during the same period last year.
But, indicative of the strength of the current market, two of the three 2002 issues,Irvine-based Standard Pacific Corp. and Tustin-based Peregrine Pharmaceuticals, Inc.,have rebounded to reflect substantial returns.
National funding activity may give evidence of what can be expected in Orange County in the fourth quarter and into 2004: On the PIPE front, common stock financing activity has been strong in 2003 relative to previous years.
About $6.9 billion in common stock has been raised year-to-date in more than 500 transactions, versus $4.6 billion and 435 deals a year ago.
Follow-ons this year generally have been well received. Although the number of deals as of Oct. 7,347, and dollars raised, $52 billion,is on par with 2002, investor reception is better.
Through Sept. 25, the average discount from filing to pricing was about 2.3% this year, compared to 5.6% last year. Follow-ons in 2003 traded up an average of 2.4% on the first day following the offering versus 1.6% last year.
In terms of industry concentration, investor interest has been across the board, with technology, healthcare and financial services accounting for more than 50% of the dollar volume.
The number of initial public offerings continues to lag behind both PIPEs and follow-on offerings.
By the first week of October, 32 common stock initial public offerings were completed, compared to 61 in the same period in 2002.
Although the number of initial public offerings this year is almost half of that last year, two-thirds of the 32 offerings were completed in the third quarter.
More important than the number of deals, however, is that this year’s initial public offerings have been well received by investors, with 94% pricing in or above the range, versus 77% a year ago.
