FORTUNE 40 discussion
KAREN GIBBS: Last July, FORTUNE magazine introduced its "FORTUNE 40" -- 40 investments in a portfolio designed to weather some tough times. It was a bold and a successful idea. As of May 23rd, the diversified group of stocks, along with some bond funds, returned 12.7 percent, beating the S&P with a lot less of the gut-churning ups and downs. Now it's time to roll out the new portfolio, and tonight we're going to put it to the test, asking a couple of market pros if they'd buy these stocks.
Michael Farr is president of Farr Miller and Washington, and Richard Suttmeier uses some of the same screens FORTUNE used when he picks stocks for Joseph Stevens & Co. FORTUNE's Dave Rynecki also joins us from New York. Gentlemen, welcome.
David, let me ask you, what's new about this new FORTUNE 40?
DAVID RYNECKI: Sure. Setting aside the fact that the market has rallied so hard in the last few weeks, as Geoff mentioned earlier in the show, we've taken a more bullish stance. A year ago, you couldn't really look at the stock market and be that happy. Right now there are some positive things going on. So we have increased our weighting in domestic equities to 75 percent. We've got a 10 percent weighting in international equities and a 15 percent weighting in bonds. The major difference is that we've lightened up on bonds, which isn't a reflection of the bond rally sort of having peaked out. It's just saying that stocks look a little better. You still want to have some, a little bit of a comfort zone in there, some ballast from bonds.
GIBBS: Mike, are you that bullish? Is this bullish stance warranted for the FORTUNE 40?
MICHAEL FARR: Karen, I'm a little scared. I find myself nervous. It's been so long since I've felt bullish. Certainly for the big run-up in the market, I was just scared that prices were getting too high. The past three years have been dreadful. And yet I do find myself feeling positive and bullish right now. I think the fundamentals and infrastructure are in place for this market to rise, and I really like this, the basics of this list in the FORTUNE 40.
RYNECKI: If I could add something from what Michael said -- sorry to interrupt you there -- but we're not exuberantly bullish. What we're saying is that, yeah, the market is not inexpensive right now. The P/E for the S&P 500 is just scary in terms of where it stands next to the historic P/E. So that's where some disciplined stock picking comes in. I think your two guests today have shown that over the last few years.
GIBBS: Let's talk about some specific stocks. Look at the healthcare sector. You've got Johnson & Johnson, Medtronic, Pfizer, Stryker, UnitedHealth Group, C.R. Bard, Coventry Health Care, Invitrogen, Patterson Dental, STERIS, and Novo-Nordisk, the ADRs there. That's just some of the stocks that they see in the healthcare sector that are attractive. What do you think about those, Richard?
RICHARD SUTTMEIER: I think a lot of them are overbought right now.
GIBBS: Meaning?
SUTTMEIER: Meaning that momentum is very strong on these stocks, and you really have to think that momentum is going to stay with this market for a long period of time for this to play out. I get a little bit nervous as to levels of where the indices are right now, and I can see a correction in July if the deflationary indications start to show through in the economy that Alan Greenspan is worried about.
GIBBS: Mike, you seem to like Patterson Dental in that group. Tell me why.
FARR: I like Patterson Dental because, first, it tends to be more of a mid-cap company. They are a dental supply company. It is a great, growing industry. They have strong fundamentals in supplying almost everything that a dentist needs, and for the larger equipment, they finance it, and we have found as we've looked into the company and talked with the CFO that dentists are very good credit risks. I think that the stocks, and all of the stocks on the list have certainly run up in here in the short term, but for longer term, to have the fundamentals of this list, superior earnings power. You know, if earnings are the most significant predictor of stock price performance over time, this is a great place to start. Patterson Dental's a great name.
GIBBS: Richard, you were kind of looking over some of the major, big drug companies and going for the biotech. Tell me why.
SUTTMEIER: I like the Bristol-Myers and Merck better than, say, Johnson & Johnson and Medtronic, because they both screen better using value engine, number one, and number two, their technical patterns on charts look very good. And I like to do both the fundamental overlay using value engine and the technical overlay using my proprietary analytics. And in terms of biotech, we have a very strong biotech research department at Joseph Stevens, and we have two names that screen using very well using value engine, and they're called Cell Therapeutics and Genta Inc, both having very good potential in cancer treatment.
GIBBS: Well, let's take a look at the financial sector now. Of course there's AFLAC, and Everest Re, the reinsurance company, Sallie Mae, Texas Regional Bancshares, and then we've also got HCC Insurance Holding, Safeco, W.R. Berkley, and ABN AMRO. A lot of these are property casualty companies, David. What happens if we get another terrorist attack?
RYNECKI: Well, that's certainly going to be a risk. But I think when you're investing in AFLAC, that's not going to be a concern. They're doing more supplemental insurance related to, historically to cancer patients and they've broadened out from that. It's more of a play on baby boomers who are aging and are going to need some help with those out-of-pocket expenses that aren't covered by their basic medical insurance programs.
GIBBS: Mike, what do you think about the financial sector?
FARR: I like the financial sector very much. I think that a lot of it is still very reasonably priced. There are some pretty strong dividends in that sector as well. This list is not my ideal list of financials. The property casualty insurers do concern me a little bit. But, you know, different opinions are what makes a market. And, you know, it's tough to bet against the success rate that this list had last year.
RYNECKI: Oh, you're so kind, Michael. One year, we're like Robert Redford in The Natural. You know, we had one good season, but how would he have done if he came back the next season? So we're about to find that out.
FARR: You came back. You know, Robert Redford didn't bother.
RYNECKI: Maybe we should have just retired.
GIBBS: Let me ask you, Richard, about Sallie Mae, because it hit its all-time high this week. Too far too fast?
SUTTMEIER: There's a lot of stocks in the FORTUNE 40 that have hit all-time highs or 52-week highs, for that matter. So you're really, as I said in the opening, you're betting on a continuation of this momentum. And if the banking system gets a little testy here with potential deflation down the road, some of these profits could be really squeezed at some of these regional banks. So I really question the (FORTUNE 40 inclusion of the) Texas bank.
GIBBS: Let's also look at the technology sector there.
RYNECKI: Actually, Karen, if I could just interrupt you for a second -- I'm sorry, but, well, I'm in New York so I'm allowed to be rude -- but I think it might be important to let people know that when we say the FORTUNE 40, this isn't like a bunch of FORTUNE writers sitting around saying here are the 40 stocks and bond funds we like. There are these two screening methods that we use. One of them is the value engine that Richard uses. And we've also added something that Zacks Investment has given us in terms of trying to find the earnings momentum. So while some of these companies are at their highs, the evidence suggests that their earnings are continuing to grow, which makes us feel less scared.
At the same time, we're not saying this is the ultimate stock-buying list.
GIBBS: Okay. Well, leading this whole rally has been the technology sector, the Nasdaq doing just really well this whole year, in fact up another 31 points this week. Looking at our technology sector, Microsoft, IDX Systems, Sandisk, and Western Digital here. And of course all boats got lifted today with the hostile takeover bid for PeopleSoft by Oracle. What do you
have to say about that, Mike?
FARR: I think that a lot of the things that we liked about technology stocks for years, particularly leading into the heat of the bull market, are still true. Because they went down, we started not to like them anymore. But that technology affords greater productivity, that it can increase profit margins and everything else, is still true. It brings more dollars to the bottom line, and so I think that it makes sense with a higher beta area, meaning it's a little more volatile, that it will move up first.
Fundamentally, my company, Farr Miller and Washington, uses the same sorts of screens, and has for years, that are used in the FORTUNE 40 list, and these companies I think with superior earnings over the next few years will be very strong, but you have to look at it for the long term.
GIBBS: But you also see different things. I mean you're looking at the same list. You don't like Sandisk. Richard, you do.
SUTTMEIER: I do like Sandisk. I think that's got a great chart pattern. It is a bit overbought, but I think that's a great stock. And getting to the international, of course we could throw in some of the technology, and I would have picked a Nokia or an SAP on the international side to have that exposure and yet be in technology. And don't forget Cisco, don't forget EMC. It's a nice turnaround story. And they're both like, on value engine they have like a 5 rating, and if you look at value engines rating, out of 5,000 companies, only 84 can get a 5 rating.
GIBBS: That's interesting. And there were no Internet stocks on there.
SUTTMEIER: No Internet, and I think that's a surprise, because the value engine was really superb at the beginning of the year picking the Internet sector as a very strong sector, and it certainly proved to be so, as was the biotech sector, and as was the beaten-down telecoms.
RYNECKI: Well, Richard, there's no question about that, but what we were trying to find were some stocks where there is going to be some downside protection. And when you look at the Yahoos of the world, yeah, sort of their qualifications look great, but the multiples are so high. And I just wonder, aren't you a little scared about some of those numbers that they're still fetching? And Cisco is still up there pretty high. Microsoft gives me a little jitters and it's no where near those guys.
SUTTMEIER: Well, I admit that most of these stocks are all overbought, and Yahoo is one of them that is overbought. But on a correction of say 10 to 15 percent, they would be a good addition to the portfolio, under the assumption that the Internet's going to be a part of an expanding economy.
GIBBS: We're going to try and get to the rest of the list now. The consumer sector, CVS Corporation, Gannett, Gap, and Tribune, along with Wal-Mart, Pacific Sunwear of California, Diageo, and Unilever. And I'd like to look at the energy sector right now, the energy and industrial sector, Occidental Petroleum, C.H. Robinson Worldwide, Pogo Producing, and Total, the oil company, another international one. Let me talk to you, David. Is the consumer not tapped out then? You're betting on that engine still pumping?
RYNECKI: I think there's a lot of risk there. When you look at, though, a company like CVS, I mean people still need to go to the drug store. When you look at a company like Gannett, as a disclosure, I used to work for a Gannett flagship newspaper, known as USA Today, and I've got to tell you, that is the cheapest company you will ever find from a shareholder's standpoint. And that's a great thing, because they're just going to squeeze the money, the profits out of there no matter what happens.
GIBBS: We're running out of time. Michael, give me your favorite stock on this list.
FARR: I like Pfizer as my favorite stock on the list. I think that their pipeline is very strong. I think the valuation is reasonable, a well-managed company, and those earnings are growing. They have a lot of patent protection. But that predictable earnings growth I think will drive that price very nicely forward over the long term.
GIBBS: Richard, your favorite.
SUTTMEIER: On the list, I would have to go with the Sandisk because I like technology, and this list is I think a little short on technology in terms of its choices. And Sandisk has the very strong momentum.
GIBBS: And you've got the last word. Richard, Michael, and David, thank you very much for joining us.
Bond talk
COLVIN: Just lately loads of investors have been paying rapt attention to one particular topic: We have gone bonkers for bonds, pouring billions into bond mutual funds even with interest rates at 50-year lows. Does that make any sense? What is the smartest move now? As part of the FORTUNE 40, we've focused on five funds that we think make sense in this
environment: the Calamos Growth & Income Fund, Dodge & Cox Income, Freemont Bond, Pimco Foreign Bond Fund, and Vanguard Short Term Bond index.
Ken Volpert oversees the short term index fund as well as all the other Vanguard bond investments and he's here to help us figure it all out. Ken, thanks for being here.
VOLPERT: Thanks, Geoff.
COLVIN: Now, I presume you think that the Vanguard fund is a fabulous choice for this list, but what do you think of the others?
VOLPERT: I think the others are pretty good, as well. I think that time right now is attractive for looking at increasing risk away from Treasury securities and into corporate securities as well as high yield and emerging market. Those have been parts of the market that are really going to
benefit as the economy comes out of the weakness that we've seen recently.
COLVIN: You know, over the past few weeks, several guests on this program have really told viewers to be wary of bonds:
TIM KOCHIS: There really is only one general direction for interest rates to go from here, and that is up, and that means that bond values will go down. It's very risky right now.
STEVE LEUTHOLD: We think that there is much more risk in terms of Treasuries and in terms of top quality corporates than there is reward.
JIM ROGERS: Don't buy what everybody else is buying, and right now everybody is buying bonds. I'm not optimistic on bonds.
COLVIN: So, Ken, are these guys right?
VOLPERT: I would agree with them. I think if you look at what's happened with regard to the asset allocation for investors, somebody who was 60 percent stocks back in December of '99...
COLVIN: At the peak of the market.
VOLPERT: At the peak of the market, would be about 40 to 45 percent in stocks now if they didn't re-balance.
COLVIN: Meaning the rest would be in bonds.
VOLPERT: The rest would be in bonds.
COLVIN: And that's too heavy.
VOLPERT: ... money market, and that's very heavy right now. So investors really should be looking at moving out of bonds and into stocks, because the stock market has been reduced over the last three years and they're probably underweighted. What they need to do is look at their long-term allocation and re-balance to their long-term allocation, and that probably means
moving out of bonds and not into bonds.
COLVIN: Right. But as you suggested earlier, not all bond funds are the same obviously. There are all kinds of distinctions to make. Now, are there some kinds that look more attractive than others right now?
VOLPERT: Well, I think as the economy continues to grow, anything that is really corporate types of credits are going to do better. Now, a lot of that has already been priced into the market. We've had a huge rally in corporate bonds, a huge rally in the high-yield market. I think the emerging markets have been very strong. But I think that could continue as investors look to move away from the very kind of safe money market and Treasury type securities and into credit securities and the equity markets.
COLVIN: Right. You think Greenspan is going to cut rates next time around? He has really suggested he might.
VOLPERT: Well, if he does he can't cut them a whole lot more than the rates right now. So if he does, it seems to be already that there's a Fed cut priced into the bond market right now. So that's not going to do a whole lot for the bond market.
COLVIN: You know, Vanguard conducted a survey last year that I found just remarkable, because it showed that investors really don't know much about bonds. I was amazed to find 70 percent of them don't realize that when interest rates go up, bond prices go down. Does that worry you as you see them piling into bond funds?
VOLPERT: Well, it worries me a lot, exactly. Because right now at the very lowest rate that we've seen in the bond markets in the last 50 years, we have the highest, strongest cash flow into bond funds. And I think there's a lot of investors that are looking at past performance and not looking at really a future expected return. And when you think about it, right now a 2-year Treasury is yielding 1.2 percent. So for the next two year, an investor in a short-term Treasury security should expect to get 1.2 percentage points, and it's not a whole lot of return. But I think what they're doing is they're looking at past returns and they're trying to project into the future those
kinds of returns, much like they did in the equity markets in the late '90s and in 2000.
COLVIN: Classic small investor behavior, and I guess your message is don't be the classic small investor.
VOLPERT: Yes. The message is look at your allocation, where you really want to be from a stock/bond allocation, and then take a look at where your weights are and get them in line. Because we've had a 35-to-50 percent decline in stocks over the last three years, and many investors have an underweight to the equity market right now.
COLVIN: Ken, thanks so much for your views.
VOLPERT: Thank you very much, Geoff, appreciate it.
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