Smoke Signals
Industrial stocks, along with financials and healthcare, are the market's hot spots
By historic standards, this bull market is already middle-aged. Though investors were spoiled by extraordinarily long bull markets in the 1980s and '90s, bulls have typically lived an average of only 36 months. But while this bull run may be nearly half over, it's by no means headed for the pasture just yet.
For one thing, there's plenty of economic wind at its back. The recovery that propelled stocks in the second half of 2003 shows no signs of letting up, as economists now forecast a jump of 4 percent or more in gross domestic product this year. What's more, the world could be in store for the first synchronized global recovery in about a quarter of a century, says John Caldwell, chief investment strategist for McDonald Financial Group. A recent survey of fund managers by Merrill Lynch found expectations for GDP growth in the G-7 industrialized economies of 4.5 percent in 2004, up from 3.5 percent as was previously estimated.
Risky business. Of course, there are risks. Though the Federal Reserve has made it clear that it does not intend to raise short-term interest rates anytime soon, that could change if policymakers start to see inflation risks or the decline of the dollar on foreign exchange markets accelerates alarmingly. Already, there are fears that corporate earnings, while still rising, will grow at a slower rate in 2004. "As the recovery ages and the profits increase at a slower rate, equity prices lose momentum, sometimes leading to a plateau or a correction," says Sung Won Sohn, chief economic officer of Wells Fargo Banks.
Take technology stocks. In 2003, the stocks of tech companies in the S&P 500 soared nearly 47 percent, based in part on the 87 percent jump in tech earnings last year. This year, the pace of tech earnings growth is expected to slow to 33 percent.
But not all sectors are slowing down. The basic materials sector, for instance, is expected to enjoy earnings growth of 49 percent in 2004, up from 11 percent last year, according to Thomson First Call. This sector is benefiting from two concurrent trends: the rise in global production as well as the substantial jump in prices for raw materials. Prices on raw materials like scrap steel and copper soared more than 18 percent over the past year. Though some worry this sector is overpriced--materials stocks soared 35 percent last year and now trade at an average price-earnings ratio of 22 times 2004 projected earnings--many believe there's still some room to run. "In an environment of a weakening [dollar], strong demand from China, and good supply-side restraint, all of which underpin the strength in commodity prices, we are still overweight the sector," notes Abhijit Chakrabortti, global equity strategist for J.P. Morgan Chase & Co.
Banc of America strategist Joseph Quinlan likes big-cap stocks in this sector, including DuPont, a chemical giant that also offers a fat 3 percent dividend yield. He also likes aluminum giant Alcoa. Donald Ross, chief investment officer for National City Investment Management, favors Freeport-McMoRan Copper & Gold. Though this stock soared 154 percent last year, it still trades below its industry peers.
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