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Thursday, 20 December 2007

7 reasons to be bullish now

Last week's rally was only the start of a move up. Here's how leading money managers suggest you can take advantage of the market's bounce back.
By Michael Brush

Last week's impressive rebound in stocks was more than just a head fake. I see seven reasons why the reversal was the start of a bullish move in stocks.

A safe way to play this turnaround is to get broad market exposure, using mutual funds and exchange-traded funds. For more oomph, build positions in companies that have the right characteristics for the slower economic growth ahead. To find those stocks, I picked the brains of several managers who have excellent records at diversified domestic-stock mutual funds.

Before we go there, here's why I see better times ahead for stocks:

Reason No. 1: The smart money is positioned for gains.

There are many ways to read the minds of the smart money on Wall Street. Jason Goepfert, who runs a great Web site called SentimenTrader.com that offers a cornucopia of investor-sentiment gauges, likes to look at what commercial traders are up to.

These are the savvy investors who hold huge positions in S&P 500 Index ($INX) futures contracts -- more than 1,000 contracts -- as part of a strategy to hedge risk. (Owners of futures contracts on a stock index have the right to take delivery of the underlying stocks in the future, at a predetermined price.)

People who own index futures as part of a hedging strategy are about as sophisticated as they come on Wall Street, Goepfert believes. Over the past seven years, this elite crowd has normally held sizable short positions in index futures. But these folks recently moved to a net long position in a way not seen in years. Several other smart-money measures indicate they are now about as bullish as they get, by Goepfert's calculations. This tells me the recent lows may have been a bottom for stocks.

Reason No. 2: Joe Six-Pack is in a panic.

Sadly, individual investors typically panic and sell their stocks at the bottom. (And I'm embarrassed to confess that I've done the same thing more than once.)

Now, the average investor is in a state of panic again -- suggesting stocks will go into a sustained uptrend from here. A recent American Association of Individual Investors survey of its members indicated they were in a state of depression about stocks. About 56% of them were bearish at the end of November, the highest level since 2000. The number of bulls was at near-record lows, too.

We also know average investors are extremely gloomy because they are shorting stocks in record amounts. Investors go short by borrowing stocks and selling them, hoping to replace them later at a lower price to pocket the difference. In mid-November, the percentage of New York Stock Exchange short positions held by the public was at 70%. That's the highest since 1943, according to Goepfert.

Reason No. 3: Overall sentiment is extremely negative, too.

To be fair to those average Joes, they aren't the only ones who are bummed out about stocks. To measure the extent to which investors of all stripes hate stocks and favor bonds, Goepfert tracks the relative value of the two asset classes. On Nov. 26, investor preference for bonds over stocks came close to the highest level seen in 40 years. During the past four decades, there were 51 times investors hated stocks so much relative to bonds -- and 42 of those times, the S&P 500 Index was higher a month later, with an average gain of 3.1%.

Reason No. 4: Insiders are downright bullish.

Last week, for the sixth straight week, insider sentiment "remained firmly in bullish territory as buyers outnumbered sellers," according to InsiderScore.com. Buying by insiders, typically executives at the company in question, is a proven bullish indicator.

Reason No. 5: 'Tis the season to buy.

December is historically the best month to be in stocks. Since 1929, it's been an up month for the S&P 500 75% of the time. Each of the five times the S&P 500 lost more than 4% in November -- as it just did -- December was up, by an average of 5.6%.

Reason No. 6: The Fed is not done.

Mary Miller, the director of fixed-income investing at T. Rowe Price, expects the Fed to cut short-term rates by another percentage point over the next several months. Historically, stocks do well in a rate-cutting environment.

Reason No. 7: The economy will be fine.

Sure, the housing and auto sectors are a mess. But they represent only 9% of the economy, though you might not know it because they seem to garner 95% of the attention of the financial media, says James Paulsen, an economist who is the chief investment strategist at Wells Capital Management. The rest of the economy has been growing nicely. Paulsen thinks most economists are too negative, and he doesn't expect a prolonged period of sub-2% economic growth.

Reasons for being more positive: continued healthy wage gains and record household net worth; strong corporate balance sheets that support business-investment spending; lower interest rates; deficit spending by governments that stimulates growth; and a weak dollar that has spurred enough growth in exports to offset housing-sector weakness.

Here are some ways to play the rebound:

Go with tech-stock growth Robert Turner of Turner Investment Partners favors growth stocks in a slower growth environment. This seems counterintuitive, but it makes sense.

As the economy slows, fewer companies can generate superior growth, and that pumps up demand for some stocks because of their scarcity value. Turner is worth listening to because his Turner Concentrated Growth Fund (TTOPX) is up about 29% this year, compared with 4.4% gains for the S&P 500.

To find growth, Turner likes the "three V's" in technology: the rise of Internet video, which benefits Cisco Systems (CSCO, news, msgs); the "virtualization" of servers to increase capacity for companies, a job done by VMware (VMW, news, msgs); and the new Vista operating system, which Turner thinks will continue to help both Intel (INTC, news, msgs) and Microsoft (MSFT, news, msgs). (Microsoft is the publisher of MSN Money.)

Follow the leaders Robert Bacarella manages the Monetta Fund (MONTX) by following the smart money into companies for which investor expectations are improving. He does this by monitoring stocks' price and volume changes, checking company reports for signs of improvement and peeking at the portfolios of his most successful peers. His large-cap growth fund is up 25% this year with this strategy.

One group that stands out now is industrial companies that sell equipment, especially agricultural equipment, and machinery abroad.

Two companies in this group that look attractive are Manitowoc (MTW, news, msgs), which sells cranes, food-service equipment and marine products, and Chicago Bridge & Iron (CBI, news, msgs), a global construction and engineering company with exposure to the energy sector, where growth has been strong.

Broken but fixable One portfolio that Bacarella checks regularly is the Hodges Fund (HDPMX), run by Don Hodges. It's easy to see why: The fund is up 24% annualized over the past five years, or 10.4 percentage points a year better than its peers. Plus his fund's top holdings are updated more frequently than most mutual funds. You can check them at his company's Web site.

Hodges says he likes several well-known companies that have been beaten down in part by tax-loss selling, even though they have powerful long-term franchises. His list: Wal-Mart Stores (WMT, news, msgs), Home Depot (HD, news, msgs), Hershey (HSY, news, msgs) and Citigroup (C, news, msgs).

"At the moment they look uninteresting, but they are great companies that will adjust and do well in time," Hodges says. "Investors have knocked them down to prices where they represent good value and limited downside risk."

Big, international and safe Like Turner, T. Rowe Price fund manager Bob Smith likes large-cap growth companies, in part because they have more room to cut costs but still have enough to invest for growth. He also looks for those that have big exposure to emerging-market economies, where Smith thinks growth will remain strong even if the U.S. economy slows.
Smith ran the T. Rowe Price Growth Stock Fund (PRGFX) for 12 years, and he just took the helm of the T. Rowe Price International Stock Fund (PRITX). His former fund returned 12.9% a year over the past five years.

He points out that emerging-market governments are in better financial health than they have been in for a while. This means they will continue to spend on infrastructure improvements even if the U.S. economy slows. "Companies that are exposed to these markets are going to grow faster than those that aren't," he says.

One play on these themes is General Electric (GE, news, msgs), which gets a lift from the infrastructure build-out in places such as India and China because it sells equipment for power plants, rail systems and alternative-energy systems. There's also strong demand from the Far East for planes using General Electric's aerospace products.

Smith likes Danaher (DHR, news, msgs), an industrial conglomerate that sells water-filtration systems and manufacturing-process-control systems. The company has solid financial strength, which means that "during tough times they can buy other companies at great prices," Smith says. Schlumberger (SLB, news, msgs), down 18% since mid-October, looks like a bargain because its oil-services business should grow by 15% to 25% a year for the next three years, he says.

At the time of publication, Michael Brush owned T. Rowe Price mutual funds.

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