In 2002, "Energy Will Be a Surprise"

Stocks should advance but only by a modest 8% to 10% at best next year, according to BusinessWeek's annual investment outlook issue. According to Senior Editor Jeffrey M. Laderman, these gains hinge on an economic recovery and the earnings upturn that should accompany it. Finance, energy, and real-estate investment trusts are favorite sectors, he believes.

He cautions investors to wait for real signs of improvement in the tech sector before jumping in. These were among the points Laderman made in a chat presented on Dec. 20 by BusinessWeek Online on America Online, while responding to questions from the audience and from Jack Dierdorff and Karyn McCormack of BW Online. A complete transcript of this chat is available from BusinessWeek Online on AOL, keyword: BW Talk.

Q: First a really broad question -- what kind of investing year does BusinessWeek see for 2002?

A: Well, we believe the economy will recover later in the year, and the stock market actually is already anticipating this. It won't be a very robust recovery, so we think the stock market will go up, but by a modest amount -- maybe 8% to 10% at best.

Q: Is there any one area that should outperform next year?

A: We think finance looks pretty good, and I think energy will be a surprise. Oil prices are down now, and we think it's a good time to buy energy stocks, because as the economy recovers, energy prices are going to be higher. And for safety, [think about] real estate investment trusts. The good thing about REITs is that they pay very good dividends -- about 7.5% -- so you don't need much price appreciation to get a double-digit return.

Q: Any other sectors?

A: Insurance should be good. Since September 11, insurance companies have hiked their rates very significantly. Citigroup (C) is trying to spin out its Travelers insurance company, so that's probably a sign that there'll be higher prices for insurance stocks. We also see better earnings from chemical companies and forest-product companies [paper and lumber], and some metals companies, which indicates that some people are looking for a stronger economy. Those are very economically sensitive sectors.

Q: Is biotech a good bet?

A: I'd say you can make money there if you take a very broad basket of biotech stocks. Otherwise, you're betting on which laboratory is going to come up with the blockbuster drug. Unless you have a PhD in molecular biology, I don't suggest you do that.

Q: How does BW see the battered tech sector?

A: It has already had an enormous runup without any significant improvement in revenues or profits, so I'd be very careful about buying tech stocks right now. However, you should keep your eye on the sector, because at the first real sign of improvement, it's going to take off.

People want to love tech stocks, they want to own them, and they will look for any excuse to do so. One place you might look is in the chipmakers, and also software and outsourcing companies [the contract manufacturers that actually build a lot of the equipment that others sell].

Q: Many growth funds had a disastrous year. Do you think they may rebound next year?

A: That's going to depend on earnings growth. Those funds are full of technology, telecom, health-care stocks, etc. Technology is still dicey. Telecom is probably in worse shape than tech stocks, and there's even some weakness in the health-care sector among the large drug companies. They're not going out of business, but a lot of them are facing revenue problems because their big drugs are going off patent.

Q:BusinessWeek's Investment Scoreboard offers some insights on earnings growth there. When will we see a real upturn, and where?

A: Well, our scoreboard shows some industrial companies have the biggest upside earnings potential. Aluminum, metals, tire and rubber, truckers and shippers, etc., are all supposed to have big earnings gains next year. Of course, you've got to look at this on the year-to-year basis. If they've got really big gains in '02 on a percentage basis, it's because they were weak in '01. So in a sense, any company that had really poor '01 results will get a big bang from even modest '02 results, because any increase will look big.

Q: I'm only looking at stocks offering a decent dividend yield right now -- good idea?

A: We're very bullish on dividend investing. We have a very interesting story on dividends in this outlook. Our writer, Margaret Popper, took two stocks -- one a high-dividend stock and the other a growth stock with only a token dividend -- and she did an analysis that shows that if you're holding the stock for five years or more and reinvesting dividends, the dividend-paying stock will actually outperform the growth stock.

This won't always happen, but people investing for growth in this environment should not necessarily ignore stocks that pay dividends, because growth is uncertain, and stocks with dividends at least give you some down payment on your total return.

Q: What kind of stocks do analysts see as good bets for dividends, as per the BusinessWeek story?

A: Real estate investment trusts have the highest dividends right now, and many electric utilities. You'd have to be careful today with the utilities to separate the ones that are in good shape from the ones that have gotten themselves into trouble with Enron-type dealings. There are also good yields in the banking sector, and in foods and, of course, tobacco. R.J. Reynolds (RJR) and Philip Morris (MO) have always been very high-yielding stocks, because a lot of people don't want to own tobacco companies.

Q: You mentioned REITs. Can you discuss any that Wall Street likes now?

A: Well, there's Equity Office Properties (EOP), which is one of the largest REITs in the country, and Simon Property Group (SPG), which is the largest owner of regional shopping malls. Then there's Vornado Realty (VNO), which owns a mix of shopping malls and office buildings. One very interesting REIT is Capital Automotive REIT (CARS), a company that owns car lots, which it then leases to dealers under long-term contracts. This REIT has raised its dividend 15 quarters in a row and now yields 8.2%. That's worth looking into.

You probably want to avoid hotel REITs and apartment building REITs right now. Travel is down, and Host Marriott (HMT) even suspended its dividends this month. Apartment REITs are very sensitive to the economy, because the leases are usually just for one year. So as the economy turns down and people lose their jobs, the vacancies go up. Office and retail REITs usually have long-term leases, so the revenue is locked in.

Q: What do you think of index funds?

A: They're a good idea if you're investing for the long haul, because the fees are very low. In a bull market, a mutual fund with a 1.5% expense ratio may still be worthwhile, but in a bear market, it's a burden. With index funds, you may only be paying 0.15% or 0.2% in expenses, and the difference goes to you. If you get 1% more year after year after year, it begins to build up.

Q: How do you see Japan's tech companies in 2002?

A: Our Asian experts prefer Hong Kong, Korea, and Taiwan stocks over Japanese stocks. In Korea, they see good opportunities in Samsung Electronics. It's the world's largest chipmaker and, of course, makes consumer electronics as well. And the price-earnings ratio is 9, which makes it very attractively priced.

Q: Will the bond market be a good place to be next year?

A: Government bonds are not very promising. I don't think you'll lose money there, but there's probably more opportunity in other areas of the market. If we get the recovery, junk bonds will do very well. I strongly urge people to look at municipal bonds. The yields are not high, but it's all-tax free. And in investing there isn't too much that is tax-free.

Q: Gold funds -- a good investment?

A: Every seven or eight years, gold funds are a good investment, and 2001 was one of those years. If you've held gold funds for 20 years, you would probably still have a negative return.

Q: How many of the pundits made accurate predictions for this year?

A: None. The best forecaster in our stock market survey of a year ago was George Jacobsen. He forecast that the Dow Jones would be 8100 right now, which is 19% below where we are. He came closer on the S&P 500 and the Nasdaq. But the difference between him and the other forecasters is that they were bullish and on average had expected the Dow to be 11,000 right now.

Even if Jacobsen missed the target, he was more right than everyone else on the direction. One bad piece of news, though, is that Jacobsen is still predicting 8100 for the Dow a year from now. Let's hope he's wrong.

The Good Business Issue
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