Saturday, December 29, 2007

Best investment ideas for 2008

Back in January 2007, Jim Stack, editor of Whitefish Montana's InvesTech Research and Portfolio Strategy, surveyed the US economic landscape and didn't like what he saw. There was a growing risk of a recession, he thought. The residential real estate market was unwinding. Stack shared his worries with readers that month.


"If complacency breeds danger," Stack wrote, "then we might be sitting on a powder keg heading into 2007."

Stack positioned his portfolio in a defensive crouch, believing that the degree of risk out there, in his opinion, warranted higher caution. He avoided the financials and real estate-related sectors. His cautious bets have payed off. His managed accounts, year-to-date, are up 8.1 per cent. That beats the 5.6 per cent gain of the Dow Jones Industrial average and the 2.2 per cent increase of the S&P 500.

For worrywart Stack, its vindication of his "safety first" approach.

"We were called doom-and-gloomers," he says. "But we felt there would be a serious unwinding in the housing market. There is now some feeling of comfort at this point, if no other reason than we haven't lost money."

The year 2007 probably left a lot of investors feeling financially seasick, with its dizzying ups and downs. The blue chip Dow surpassed historic milestones, but market turbulence returned with vigor. U.S. markets were choppy and volatile as investors worked through a web of concerns: oil prices kissing $100 a barrel, a busted housing boom and ugly write-offs by big banks.

As the year comes to a close, there is a lot of worry out there on Wall Street. For evidence of that hand-wringing, just check out a simple stat on stock market volatility: the CBOE Volatility Index -- a literal measure of volatility reflecting the premium that options traders are willing to pay on the S&P 500 Index options -- spiked 250 per cent from January through mid-December. This was one of the quickest and most dramatic increases in volatility since early 1994.

Heading into the New Year, Forbes.com checked in with a few market pros to see where they're putting money in 2008. These gurus had some wide-ranging opinions on how they plan to position their portfolios, which sectors they like and which ones they're planning to avoid. These big-picture professionals were at odds over which areas of the market had the most prospects and where they would counsel investors to commit capital.

Let's start with a sector that has made headlines this year for all the wrong reasons: the financials. Wall Street heavies like Citigroup and Bear Stearns suffered big losses due to risky mortgage-related holdings that went bad. The Financial Select Sector SPDR is down, year-to-date in 2007, about 20 per cent.

But are these financial companies ready to turn around in 2008?

Stack isn't buying primarily because he expect "extreme volatility" in the financial sector in 2008. He cautions investors to avoid the companies until they see at least three to four months of bottoms in stock prices. Only then, Stack says, should investors start to think about pushing money into the sector.

"There is so much still coming out of the woodwork," Stack says. "How do you judge the internal risks when all the unknowns aren't out on the table?"

By contrast, "growth at a reasonable price" fan Jim Oberweis, editor of the Oberweis Report, thinks there could be some opportunity in this sector. "My inclination is to buy early out the gate," Oberweis says. "Don't wait too long."

In the financials, Oberweis says to look for cheap valuations. He says one possibility, for example, is Citigroup, which has gotten badly beaten up this year (the stock is down 45 per cent), but is now trading at eight times estimated earnings.

"If those earnings are correct, that is a bargain," Oberweis says. He notes that the company has historically traded at an estimated price-to-earnings ratio between 10 and 15.

In contrast to the fumbling financials, materials have turned in a strong performance in 2007. Materials Select Sector SPDR is now up, year-to-date, about 17 per cent. But some market pros aren't so sure the sector can turn in another solid performance next year.

Art Hogan, chief market analyst at Jefferies & Co., is a skeptic.

"Materials are not going to outperform," he says. "A lot of material prices are driven by an accelerating global economy. But now that economy is decelerating. So materials will come under pressure."

Hogan adds, "On the whole, we will still have strength in non-Japan Asia. But the magnitude of the increase will be less. You will have efforts to slow the Chinese economy, for example, to a sustainable rate. If China slows its economy down to, say, 9 per cent or 8 per cent, that slows the global economy to 4 per cent."

Oberweis is also down on the sector, but for a different reason. He doesn't tend to find a lot of materials companies that hit his 30 per cent minimum growth rate requirement.

Rather than materials, Hogan prefers energy, where he sees real opportunity. Energy Select Sector SPDR jumped 30 per cent year-to-date. And he continues to favor health care, where his picks include Array BioPharma, a Boulder-based company where he sees strengthening fundamentals.

Oberweis is wary of health care stocks in 2008 despite demographic trends heavily in favor of robust health spending.

"I think health care is somewhat subject to the political arena," he says. "The leading candidate is someone who has historically advocated a government takeover of the health care system. That wouldn't obviously be a good thing for health care companies."

So Oberweis plays the sector through health care-related tech companies. He likes Hologic, which invented a new way to test for breast cancer. Revenues were up 60 per cent in 2007. And he favours Intuitive Surgical, which makes robotic arms used in surgery. Revenues at the company were up 60 per cent in 2006 and 2005, and 50 per cent in 2004.

One sector Oberweis is extremely bullish on in 2008 is technology, which had a strong year in 2007.

Says Oberweis, "Tech will be the sector for 2008. U.S. tech companies are likely to exhibit accelerating earnings growth. Stock valuations, by historical standards, are reasonable."

One Oberweis pick in the tech arena is Santa Clara, California-based Synaptics, which creates products for electronic devices. The company has a market cap of about $1.4 billion. Compared with its industry peers, it has better operating margins and is cheaper on expected growth.

Alec Young, equity strategist at S&P, agrees that tech is a smart bet.

"We are looking for 24 per cent earnings growth there," Young says. "That's above average. Earnings visibility is weak for most sectors. Investors are willing to pay up."

Young adds, "There is still a lot of consumer demand for electronics. There is lots of growth in the emerging markets and also a great deal of excitement around game consoles. Tech still looks OK."

Belt and suspenders guru Jim Stack thinks buying tech stocks is a mistake.

"Keep in mind, if you line up the 10 major S&P 500 sectors, as far as downside risk in a bear market, over the past 35 years information technology is right at the bottom," Stack notes. "Historically, it's one of the highest risk areas in a bear market. In a recession, an easy way for businesses to cut back is those technology upgrades."

For those risk-averse investors worried about the possibility of a recession, Stack recommends consumer staple stocks, which provide cover for investors during down periods in the economy and markets. Year-to-date, the Consumer Staples Select Sector SPDR is up 10 per cent.

"These are the things that the consumer has to buy after gas prices take the wallop out of their wallet," Stack says.

Among consumer staples Stack prefers is PepsiCo.

He says the beverage and snack food company ideally meets his investment criteria of having superior profitability, dominant market share and excellent financial standing. The company should generate in excess of $4 billion in free cash flow in 2007, which should easily allow it to raise its dividend for the 36th consecutive year, Stack says.

The US consumer is under some pressure right now, facing rising energy prices and housing woes. Those worries have sent consumer discretionary stocks tumbling. The Consumer Discretionary SPDR has dropped about 14 per cent this year.

But, so far, consumer spending doesn't seem to be rolling over. In fact, retail sales rebounded in November, rising 1.2 per cent and beating analysts' forecasts.

Jefferies' Hogan is bullish on a number of global luxury brand retailers. "There is a great deal of international demand for Tiffany and Coach," he says. "Have you been to Tiffany in New York City? People come in by the bus load to spend euros."

Given market volatility and the ugly surprises investors experienced during 2007's wild market ride, there is one bit of investment advice all of the gurus agree. Stack sums it up well: "Stay skeptical and do your own homework."

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