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Agreement
is growing that the economy has taken its medicine and
is feeling better.
The
patient apparently has been prancing about the sick ward
this quarter, and reports on the economy and corporate
profits for the third quarter are expected to show it in
a few weeks. Longer term, the prognosis is not as
encouraging, with many economists still expecting a bit
of a relapse in 2010 as the U.S. and
Europe
remain bogged down with bank troubles and unemployment,
and
China
craves Western customers for its exports.
If that's
true, what's an investor to do?
Even the
most skeptical strategists and economists are starting
to suggest that perhaps investors who keep their eye on
the exits might eke more rewards out of the rally that
began in March.
For
example, with stocks up so dramatically,
David Rosenberg
, a longtime bear and strategist for
Gluskin Sheff & Associates
, argues that though stocks "have far too much
growth priced in at current valuation levels," the
market momentum could carry them higher for a while.
When
corporate earnings are reported in a couple of weeks, he
expects a lot of companies to show stronger profits than
expected. And one surprise after another often sends the
message to investors to buy more stocks, at higher
prices.
Still,
when stocks become pricey — as they are based on
Rosenberg's numbers — any disappointment can bring
them down before an investor has time to flee.
Despite
that,
Thomas Lee
, a
JPMorgan
strategist and self-professed "contrarian,"
told clients in a recent conference call to wade into
riskier stocks.
If
investors have "fresh money" to invest for
three to four months, he said, he thinks it's worth
betting on cyclical stocks.
With
cyclical companies, he said, an investor can receive
"100 percent of the benefit" of a recovery.
And Lee said he anticipates a
"stronger-than-anticipated economic recovery."
Cyclicals,
which conversely could be dumped if growth stalls, are
industrial companies or those that make or sell basic
materials, technology or energy — the stuff that
growing firms need and confident managers buy if sales
are starting to increase. For example, Lee anticipates
United Parcel Service
will do well as shipping increases, and
Illinois Tool Works
will benefit as industrial production picks up globally.
In
addition,
Delta Air Lines
is a pick for the eventual return of business travelers,
and
Starwood Hotels
is expected by
JPMorgan
analyst
Joseph Greff
to benefit from a recovery in lodging in 2011.
Most of
Lee's selections do a large portion of business in areas
where the recovery is expected to be stronger than in
the U.S. or
Europe
.
Though
recovery could take a while, the expectation is that
investors will buy stocks in anticipation of better
times, searching for firms in the next few months that
have made cuts and other changes to position for a
leaner environment. Already, some cyclicals have moved
up sharply in price, leaving them especially vulnerable
if expectations don't come true.
Companies
that produce building products have climbed 224 percent
more than the median performance of cyclical industries,
and forest and paper products are 135 percent ahead of
the median, Lee said. The biggest laggards since March
have been hotels, restaurants and diversified consumer
services.
That
doesn't necessarily mean they are cheap. Analysts have
been upgrading their expectations for cyclical stocks
since June, and Greff, for one, is concerned that
lodging stocks have risen too quickly.
Lee said
he thinks 99 percent of cyclical companies will be
profitable in 2010. Still, short interest, or investors
betting the stocks will fall, is higher for cyclicals
than for defensive companies that make products people
need regardless of the economy.
History
provides mixed messages.
"Whether
it is currently time to overweight cyclical or stable
stocks is not clear from the historical record,"
said
Wells Capital Management
strategist
Jim Paulsen
. After the lows in recessions in 1981-82 and 1990-91,
he said, cyclical stocks led briefly, but the defensive
stocks "took leadership and never relinquished it
again until the bottom of the next recession." Yet,
after the recessions in the 1970s and 2001, cyclicals
dominated for years.
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