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Contents » Opening » Investor spotlight: Steve Leuthold » Roundtable:Fortune All Stars » Guest Profiles

GEOFF COLVIN: Well, what does this little bottle have to do with the market's remarkable runup these past several days and past several weeks? The answer is: more than you may think. This is part of the household sector: ordinary, every day things. But the companies that have been making them have been performing very well lately and may keep performing very well into the future. We're going to talk about it this evening.

Now Karen, what is that thing that you’ve got there?

KAREN GIBBS: Geoff, I have a new medical device, it’s a breath-activated inhaler manufactured by Ivax and has the potential to change the way people live. And savvy investors like our guest tonight, Steven Leuthold, have identified companies such as Ivax, that are doing ground-breaking things, particularly in the health care industry -- a sector that has surprised many this year, and is one of the sectors we'll be discussing tonight.

COLVIN: You know, the profitability of some of these products, especially personal care products is just incredible. This is Estee Lauder Perfectionist Correction serum for lines and wrinkles. Now, for perspective, you figure gasoline costs $1.50 a gallon; Coca-Cola, if you buy it in a vending machine, works out to about $6.40 a gallon. The little bit of liquid in here works to more than $6,600 a gallon.

GIBBS: Geoff, I can’t afford that. Can I have that when you’re done?

COLVIN: Yeah, sure. Not that you need it.

GIBBS: Thank you.

COLVIN: It’s a beautiful business, though, as you can see when we talk about it this evening. We’ll also talk about the insurance industry, which is hot these days with so many people buying annuities, so many people retiring. And we’re going to talk about these with two members of the new team of FORTUNE's All-Star analysts.

Investor Spotlight: Steve Leuthold

KAREN GIBBS: When you think about All-Star analysts, you think about all star managers. Who better to turn to than Steven Leuthold, the grizzled veteran likes what he sees in the market now. His core investment fund is up 13 percent so far this year, and up 7 percent over the past 5 years. So now we're going to put him under the Investor Spotlight. Steve, welcome back.

STEVE LEUTHOLD: Nice to be here, Karen.

GIBBS: You know, in reading your research I was struck by a seismic change. You've become Wall Street's version of Jake LaMotta, a raging bull. What's behind this enthusiasm for stocks?

LEUTHOLD: Well, I think to survive in this business for as long as I've been in it, you've got to be flexible. I mean there was a time when in the early 80s when Barron's called me super bull, and then I became a perma-bear, a lot of people thought, in the late 90s. But we really have been very, very positive toward the market really since last October.

GIBBS: Incredibly we have seen a really good run. The Dow up 248 points this week, up 6 percent year to date, and up 21 percent since the October lows. Is now the time for large-caps?

LEUTHOLD: Well, I think it's going to be pretty much a horse race between large and small-caps for the rest of the year. Normally small-caps have the capability of growing faster, but I think we've got another factor here. The public is not terribly involved in the market, and you really have a lot of under-funded pension funds that have to buy big-caps for liquidity or index money. And so I think it's going to be a horse race between small and large-caps for the rest of the year.

GIBBS: How can the market turn around if the investing public is so untrusting and so afraid?

LEUTHOLD: Well, you don't need the public to make the market go up. We've only had one period in my 40-some years in this business where the public has been the prime driver of the market, and that was '97, '98, '99. And otherwise, professionals are the prime movers, whether they're pension funds or whether they're hedge funds or whether they're just large, sophisticated investors. Rarely, rarely does the public lead a market or drive a market. The typical thing is for the public to come in at the top and sell at the bottom.

GIBBS: And that's what we saw in March of 2000.

LEUTHOLD: Yeah, we did.

GIBBS: And now we're seeing the S&P, it's up already 9 percent year to date and up 25 percent from the October lows. And you're anticipating an even bigger move, up 25 percent from current levels. Why?

LEUTHOLD: Well, we looked at and analyzed the cyclical bear markets that came after the 1973-'74 crash. Actually it went back to '69 through '74. And we saw four distinct cyclical bull markets in the aftermath of that, and on average they went up about 65 percent, ran for about two years. Now taking that, and not saying this is a new secular bull market, but using that as kind of a guideline, the way we look at it, from current levels you've got another 20 to 25 percent to go for the S&P 500, maybe 1150, 1200. We've got probably about the same 20 to 25 percent in the Dow, and the Nasdaq I think could run 40 to 60 percent from where it is now.

GIBBS: That would be good news for a lot of people that did step in in March of 2000.

LEUTHOLD: But again, there's probably going to be a time to sell them, too.

GIBBS: That's the other thing. Where are you going to see the leadership? Who's going to be the drivers of this rally?

LEUTHOLD: Well, it looks very much like it's going to be, continue where it's been since the first of the year, and that's in technology. Although everybody had almost given up on technology. But this is where you're seeing the most earnings surprises, because analysts have become so, so negative about the industry.

GIBBS: And their expectations so low.

LEUTHOLD: Right, right. And now, now you're seeing surprises come in. You're seeing earnings momentum there on a year-over-year basis that's pretty strong. Stronger than financials, stronger than a lot of other areas. And I think that's going to build. They're pricey. There's no doubt about it.

GIBBS: But there are some bargains. Who are you buying in the technology arena?

LEUTHOLD: Well, we have some of, well, we had a pretty good one today, McData that we had that was up big today. But we also have what I call chicken technology stocks, which are, people might say they're really not tech, but things like Canon and Xerox, which is a great turnaround story. These are companies that are involved primarily in office equipment and office technology. And we have the Ciscos, and we have a whole array of networking stocks.

GIBBS: Cisco ever going to get back to $70?

LEUTHOLD: Oh, probably not. I'd be happy if it goes to $30, though. (Laughter)

GIBBS: Well, in one of your portfolios you have 31 percent, and you're talking about the Nasdaq. You're saying another 50 percent increase. We've already been up like 43 percent from the October lows. It's up 20 percent year to date, outperforming pretty much all of the indices. Is it too far, too fast, or is it the real thing?

LEUTHOLD: Oh, I think we've gone too far, too fast, and I think there's probably going to be some kind of a correction or consolidation. And our targets, when we say up 20, 25 percent in the S&P and up 40, 60 percent in the Nasdaq, we're talking about over the next 12, 13, 14 months. No markets go straight up, and this one is probably going to consolidate.

But we're really only about 10 percent, by our calculations, above median valuation levels for the market as a whole right now. And we combine a lot of factors, price to cash flow, price to sales, as well as P/E multiples, and the quality of the earnings is better. Reported earnings are coming in just right pretty much in line with operating earnings now. So I think we've got an earnings-driven market, and just a little stronger economy I think is going to put some pretty big numbers in the bottom line for a lot of companies.

GIBBS: How about the health care sector?

LEUTHOLD: Well, I like them. They're our, health care and technology are our two prime areas of sector concentration. We are kind of around the edges of health care, though. We haven't bought the big pharmas yet.

GIBBS: Why is that?

LEUTHOLD: Well, they're still under too much of a political attack from the state levels, the federal levels, and so on. We think generics are a better way to go, which includes your Ivax that we talked about and Teva and some other ones. I think that's a better way to go. They're ones that are involved in helping control health care costs.

And then we have something we call health care cost containment, which are companies that are involved in keeping health care costs under control or helping control them, and then we have some biotech, too. That's pretty aggressive.

GIBBS: Yeah, that is. Now, I also see that you're short in U.S. Treasuries. That sounds a little un-American in this environment. And Leuthold doesn't sound French to me. What's going on there?

LEUTHOLD: Well, we have had the biggest secular bull market in bonds that we've ever seen in this country. Rates have gone from 15 on a 10-year bond down to about a 3.40 or 3.35 right now. No trees go to the sky, not even the bond market, and we think that there's much more risk in terms of Treasuries and in terms of top quality corporates than there is reward. And even if rates go down another 50 basis points, let's say on the 10-year bond down to say a 2.80. This short will only lose 5 percent for us. And we think that you're probably going to see rates go up at least 100 basis points over the next year or so.

GIBBS: Not good for the financial sector either then right?

LEUTHOLD: No. We do like, we still like high-yield bonds, because the ratios still work out right and they're still attractive. But we have hedged our 15 percent position in high-yield bonds by shorting some of the 10-year Treasuries, and we may do a little bit more.

GIBBS: What would change your bullish position on the stock market?

LEUTHOLD: Well, I think the major risk, and it's a risk that we cannot anticipate and I can't figure out with the 170 factors that we look at every week, is the risk of a terrorist attack in this country. And I'm sure there would be a very violent reaction in the U.S. market if there was a major, major attack on our land. But nobody can predict that. We see that we're back to a, what, yellow from orange now?

GIBBS: Yes.

LEUTHOLD: But that is a risk, and it's a risk that I think you just have to take because there's no way you can judge it or evaluate it.

GIBBS: All right. Steven Leuthold, such a pleasure to see you again. Thanks for joining us.

LEUTHOLD: Karen, good to be here.

Roundtable: All-Star analysts

GEOFF COLVIN: Well, baseball fans haven't finished picking this year's All-stars but we’ve already got ours: FORTUNE's fourth annual All-Star analysts, Wall Street's very best stock researchers.

This team fields only eight players, but these are genuine heavy hitters. Last year, every one of them beat the market and beat the average analyst in his sector.

• Prudential’s Michael Bruynsteyn covers the auto industry and likes Gentex, a maker of headlights and mirrors.
  
• Retail analyst Robert Buchanan of A.G. Edwards likes Hot Topics. You may never have heard of the chain but if you have teenagers, they have.
  
• Joseph Campbell is a Lehman Brothers defense analyst. He thinks Boeing has fallen so far it's now a buy.
  
• Richard Chu covers technology for SG Cowen and believes Hewlett-Packard’s printing and imaging business alone is worth more than the price of the stock.
  
• Energy analyst Michael Mayer of Prudential recommends ConocoPhillips, a rare example of a merger that’s actually working for shareholders.
  
• And David Stumpf, the banking analyst for A.G. Edwards, says Wachovia is still a buy even after its recent runup.
  

Those are six of the eight. I'll talk with the other two in just a moment.

But if you're wondering about the All-Stars we met on the program last year, here's an update. Market strategist Vadim Zlotnikov's picks are up 4.1 percent, beating the stuffing out of the Wilshire 5000 index, which is down 2.3 percent. Biotech analysts alex hittle and craig west, the so-called biotech twins, picked stocks that are up 15 percent, which sounds good, until you realize that the biotech sector overall is up 40 percent to 60 percent.

COLVIN: And now let's meet the two remaining members of this year's All-Stars. Andrew McQuilling covers the household products and personal care industries for UBS Warburg. Colin Devine analyzes life insurance companies for Smith Barney. And Steve Leuthold pulls up a chair as well.

Colin, we're in a time when people still say analysts don't know how to say sell. They never go negative. And it's worth remembering that there was a time when you became famous for going negative on Conseco. In fact, you angered some investors so much that one of them, Irwin Jacobs, took out a full page ad in The Wall Street Journal, mostly lambasting you, saying Devine deserves the Academy Award for best actor in ineptness and/or desperation, which must have hurt. But of course you turned out to be right. Conseco went bankrupt. You were under huge pressure. Were you ever tempted to back off?

COLIN DEVINE: No. My strategy has been the more they squeal, the more we put the pressure on them. And that's what we did, and we did a lot of homework and we felt we were right.

COLVIN: As you turned out to be. The stock was at $19 when they ran the ad; it went to zero.

DEVINE: It did.

COLVIN: Congratulations once again. You're on the All Star Analysts because your return in 2002 was 15 percent. The other guys, the average analyst in your sector was down 4 percent. That's a big margin. Your top pick now is Prudential Financial, and we learned today that Prudential is being investigated by the NASD for annuity sales practices, allegations of forging customers' signatures, violating other rules. Is that a small problem or a big problem?

DEVINE: I think it's a pretty small problem. The company brought the issue to the attention of regulators. They've already reached a settlement, and notices will be going out to customers. So I think it's certainly fairly insignificant.

COLVIN: Well, why do you like Prudential so much?

DEVINE: I like Prudential because I think where you can make money today long term is investing in the sort of graying of America theme, playing to retirement. And if you look at the demographics, the number of people who will retire over the next 10 years, even really focus on the age 50-to-70 bracket, that's the sweet spot in financial services, and they've got the products to sell into that.

COLVIN: Annuities and so forth.

DEVINE: Annuities, and annuities not just as an accumulation vehicle. Everybody thinks about them as a savings vehicle. I think what they forget is that they're primarily there to be an income vehicle, and you don't have the pension plan that you used to have from your employer.

COLVIN: Right. So retirees will want and need that income.

DEVINE: Their risk is outliving their savings.

COLVIN: Yeah, exactly.

STEVE LEUTHOLD: But Colin, how do they sell this when you've got yield so low? I mean you look at yields that are terrifically low, and then you look at the stock market that people are still frightened of. I mean what's the life insurance industry going to sell?

DEVINE: Well, it's getting harder and harder to find something to invest, particularly if you're talking life annuities. And we may yet see the 30-year bond come back so you've got something to hedge against. That's a challenge, absolutely.

COLVIN: Andrew, you were up 14 percent last year. The other guys, the average sector analysts for you was down 4 percent, another big margin. Your top pick is Estee Lauder, maker of that little product we were looking at a little while ago that sells for the terrific price. But Estee Lauder has had a good run these past six months. Does it still have room to run, especially selling luxury products in an economy like this?

ANDREW McQUILLING: We think it does. Est‚e Lauder, you know, in mid-'99 was about $60 a share. So really we began 2003 near relative lows, about $26, $26.50. So the recovery from the bottom has been good, but still I think there's plenty of room. It's an operationally-leveraged business.

COLVIN: You cover a lot of companies that everybody knows about, everybody buys every day. Gillette, Avon, Procter & Gamble, things like that. A lot of them are interesting. Procter & Gamble, up strongly. It's had a great run since its famous crash in early 2000. Again, it's had a terrific comeback under A.G. Lafley. Do you think it still has room to go?

McQUILLING: I think it does. In truth, over the last 2 years, the household product sector started this runup at 40-year lows relative to the market and bond yields. Obviously it's a defensive sector. It really did its thing. It did what it was supposed to do. But Procter & Gamble right now is still only about 19, 20 times earnings on calendar '04. Its valuations are reasonably below long-term historic averages, and fundamentals are good. I think they'll continue to exceed the earnings expectation.

COLVIN: Colin, we've had a little more excitement than we're used to in the insurance business the last few weeks. At John Hancock the CEO, David D'Alessandro, is under a lot of fire for his pay, $21 million and change, at a time when the company did rather poorly. He's being sued in fact over that now. What happens next?

DEVINE: I'm not sure what's going to happen next with Hancock. We're certainly not as bullish as some that perhaps the company's going to get sold. David's made no secret of the fact that they've got the company up for sale. In terms of the executive compensation issue, I think it's out there and certainly shareholders and the market's holding them accountable for it.

LEUTHOLD: Even Mr. Grasso in the financial area.

COLVIN: Even Mr. Grasso.

LEUTHOLD: Yes.

COLVIN: Steve, I want to know what you think of the sectors these two guys cover, in life insurance here, household products and personal care there.

LEUTHOLD: Well, life insurance has always been one of my, I've had a bias toward life insurance stocks ever since I started about 40 years ago in this business. But to me the life insurance industry has a real problem facing it now in terms of designing and putting together products that people are going to want to buy. There will always be the protection aspect of it where people are going to want coverage in case, I guess we should call it death insurance, not life insurance. But in terms of developing other products, it's a very difficult environment right now. We rate the life insurance industry as being neutral now in our work, not negative, but neutral.

And in terms of the household products, I mean the performance there has been just great. These stocks always seem too high, but they always seem to keep going up. And you buy a package of these, and you'd be a lot better off than if you bought a package of racy technology stocks five, six, seven, ten years ago, you'd be better off here.

COLVIN: Andrew, you've made a couple of great timing calls on the sector overall. You called a high very well, and you called a low very well. Where do you think we stand now?

McQUILLING: Right now, in terms of relative to the S&P 500, I could see the sector potentially giving 5, 10 percentage points back, given that it is a little above historic averages. But fundamentals are good, and earnings should continue to exceed expectations. We have some positive trends, especially in the U.S. dollar weakness. Most of the companies I cover are very international.

COLVIN: Well, that's actually a great topic that we need to get into, because the dollar is big news all of a sudden, and it's very important in the fate of the companies you cover. And I know you personally pay a lot of attention to it. What do you think is going to happen?

McQUILLING: Well, I have to admit, we don't forecast currencies, but at least we do keep an eye on where they are and the outlook for currencies at least three, six, and nine months forward. And there are some very good euro leverage stories, euro strength stories. Estee Lauder probably the strongest euro exposure. Gillette, another big exposure. And this should benefit earnings through the end of the calendar year.

COLVIN: It's good for all of them, as those foreign currency earnings get translated into dollars.

McQUILLING: It was awful for seven years, and we deserve a little give-back.

COLVIN: Although with the dollar at these incredibly low levels, if it starts turning around a bit then it all gets taken back, right?

McQUILLING: It is a challenge, and you continue to monitor. You continue to monitor.

LEUTHOLD: How much hedging do the companies do there? They've got to hedge a lot of the currency risk don't they?

McQUILLING: A company like Procter & Gamble will hedge three to six months forward in order to help manage earnings, and P&G can do that because its large exposures are Europe and Japan, where it's cost efficient to hedge. A company like Colgate-Palmolive, 72 percent of sales overseas, its emerging market currencies are very difficult to hedge, so they tend not to hedge at all.

COLVIN: Colgate is one of the great growth, great stocks of the past 15 years. I think the CEO, Reuben Mark, is one of the great unsung CEOs of our time recently. But the past three years the stock hasn't gone any place. What do you think of it?

McQUILLING: It's not Reuben's fault. The stock I guess, in late '99 the stock was trading at 40 times forward earnings.

COLVIN: Unsustainable.

McQUILLING: That's the challenge. And the results have been wonderful really since late '99. Colgate has put up probably the best numbers in the space absolutely. The valuation was the challenge. And the company, its earnings have earned its way into the stock price. I think it's attractive right now.

COLVIN: It's reasonable and attractive.

McQUILLING: Yes.

COLVIN: Colin, you have made some pretty good predictions, but one of the most interesting is that you'll be out of a job in three years. Now what did you mean by that?

DEVINE: I'll be out of a job because I won't have a sector left. I mean life insurance is a growth business, and it's a growth business because of the retirement savings. It's not a growth business in protection, 3, 4 percent a year. Retirement savings is probably 15 percent. These are growth companies. If you look at AIG, Hank Greenberg spent $50 billion buying into the sector in three years. He thinks it is, too, and you're playing to people getting older, selling products in retirement that really protect them against living too long, not the sort of traditional protection products of dying too soon.

COLVIN: So, life insurance companies, pure life insurance companies are going to disappear.

DEVINE: I think you're going to see them all bought up. Rising capital costs, rating industry pressures, access to distribution is getting tougher and tougher. And I think you will see them become part of bigger financial services companies.

COLVIN: So they'll all be part of conglomerates, and you'll have to figure out how to analyze something else.

DEVINE: I'll have to figure out something else, or I think I'll probably become a financial planner. That's going to be my next job.

COLVIN: Well, that's playing the trend, right?

DEVINE: That's where I'm going next.

COLVIN: That's playing the trend.

DEVINE: That's where I'm going next.

COLVIN: Actually another trend, Andrew, that I need to ask you about has to do with a company you cover, Weight Watchers. What a story they have been since they went public two, three years ago, a huge runup. Now, I think of two things when I think of them. One, obesity is a big problem -- not to pun -- but it's a big problem in the United States and getting worse. On the other hand, the stock is up so much recently. Does it have anyplace to go?

McQUILLING: Sure. It was a wonderful stock from IPO, doubled at the high, so I guess it IPO'd about $23 a share. It has some wonderful secular trends. It has something like 64 percent of Americans are overweight today, and so obviously the seculars are good. The stock, you know, the stock valuations to me seem attractive.

COLVIN: It's still okay.

McQUILLING: Still okay.

COLVIN: We don't have much time, but I know we've got to do disclosures and disclaimers.

LEUTHOLD: There's only one at this table that looks overweight.

COLVIN: No, you look great.

McQUILLING: No, we've got to do disclosures.

COLVIN: Disclosures, please. Andrew?

McQUILLING: One disclosure -- no disclosures for Estee Lauder, Clorox, we didn't get to discuss, so I think we're fine.

COLVIN: Colin?

DEVINE: Okay. I have to say that Citigroup or its affiliates beneficially owns one percent or more of any class of common equity securities at Prudential Financial or John Hancock and that Prudential is a banking group, a banking client of Citigroup.

COLVIN: You did that with admirable compactness.

DEVINE: Thank you.

McQUILLING: Geoff, you'll have to come back to me.

COLVIN: Okay. Yes, do you have another one? I'm sorry.

McQUILLING: Yes. Weight Watchers, it's a firm client. P&G is a firm client.

COLVIN: Okay, we're good. Colin, Andrew, Steve...

LEUTHOLD: I own every stock that I mentioned.

COLVIN: Easy. Thank you.

Karen and Geoff also discussed financial Web sites online. Click here for Wall $treet Week with FORTUNE’s Web Resources for Investors.