Local stock experts brace for a market correction
Some of the investors hoard cash as they await a Dow pullback of 10% or greater
A YEAR AGO, investors were anticipating the end of rising interest rates.
Now, those same investors are bracing for a correction that many think is long overdue.
It's not easy climbing that Wall of Worry-- market jargon for the nebulous barrier that always seems to hold back stocks.
But this time history is on the skeptics' side because the Dow has gone 53 months without a 10 percent correction for only the second time ever, according to Ned Davis Research.
Local stock experts, tiptoeing through the first half of 2007 with trepidation, are either clinging to their cash so they can buy on the dips or selectively picking stocks that can withstand a market drop. Two of the four experts in this year's Star-Bulletin survey of best investment ideas are keeping unusually high cash positions while a third has a portion of his portfolio stashed in a bond fund.
"Market complacency and valuations are high enough to justify a short position," said Barry Hyman, vice president-management team for the Maui branch of Michigan-based FIM Group Ltd.
" With earnings growth facing headwinds, mutual fund cash levels near record lows, and stocks trading at or above historic average multiples of estimated earnings, I see ample room for a wake-up call in the market."
Hyman, who's been cautious on the U.S. stock market for several years, beat out five other local experts in 2006 with a 19.5 percent return in the fifth annual Star-Bulletin contest.
He's back again this year to defend his title. Opposing him are returnees Richard Dole (up 15.5 percent), chief executive of Honolulu investment adviser Dole Capital LLC; Norm Caris (up 14.4 percent), who lives on Kauai and is managing director-institutional sales for Caris and Co.; and Dwight Melton (down 19.9 percent), a former two-time winner and the co-founder of the Hawaii Stocks and Options Group.
Declining invitations to return were Alan Matsuda (up 8.4 percent), a Hawaii Kai-based certified financial planner and registered investment adviser; and Irwin Yamamoto (up 4.9 percent), editor and publisher of The Yamamoto Forecast.
Each of the four returning experts began 2007 with a hypothetical $20,000 portfolio and made their picks at the start of the year even though they're not being published until February due to time constraints. Just like last year, the experts will be allowed to change their picks at the end of each quarter.
Interestingly, Hyman and Dole, the top two finishers from 2006, are at opposite ends of the spectrum this year when it comes to the Nasdaq, or more specifically, the Nasdaq-100 index that is comprised of the top 100 non-financial stocks.
Hyman is selecting among his picks the Ultrashort QQQ ProShares, a double inverse Nasdaq-100 index exchange-traded fund "that should benefit from our view that U.S. markets are priced for perfection and likely to disappoint." Ultrashort QQQ ProShares will rise when stocks in the Nasdaq 100 go down.
Dole, on the other hand, is sticking with the technology-heavy Nasdaq-100 Trust index fund for the second year in a row in the belief that those stocks will rise.
"The Nasdaq has somewhat lagged the other indexes," Dole said. "My thought on the market, in general, is not that I'm looking for a crash or a general market decline.
"I believe the general market is ahead of itself, particularly in the commodity-driven large companies that are being acquired, like Alcoa. The Nasdaq, in general, has lagged the other indexes and my belief is that technology will be a leader in the economy and the technology-oriented stocks will move faster in the market than the large-cap companies."
Hyman retained one selection from last year's contest, the iShares Lehman 1-3 Year Treasury Bond Fund, in order to have available cash to take advantage of other opportunities. He looked overseas for his two remaining picks -- Tally-Ho Ventures, a low-priced European niche financial services company that is counting on acquisitions to drive profit growth; and Mitsubishi UFJ Financial Group, a Japanese megabank that is expected to benefit from normalization of Japanese interest rates and growth in fee income.
For a conservative investor like Hyman, the selection of Tally-Ho, trading at $1.06 at the beginning of the year, is rather speculative. But Hyman said investors could take a small position of that stock in a portfolio with the idea there could be a lot of upside, as well as significant downside that could result in the company going out of business.
"At first blush, this looks very speculative," he said. "It has a silly name, trades at around a dollar U.S., and is not very liquid. On the other hand, if they can execute their business plan, we expect it to be very profitable, and at its price at the start of the year, it was selling for less than five times what we think they can earn in 2008."
Dole, who was the only local expert to keep the same picks for the entire year in 2006, is sticking with those same selections in 2007. In addition to the Nasdaq-100 index fund, he likes Newport, a supplier of scientific and technical instruments; defense giant Lockheed Martin; pharmaceutical behemoth Pfizer; and Honolulu-based Alexander & Baldwin Inc., which is the parent of Matson Navigation Co.
The only one of Dole's picks to decline in 2006 was A&B, but he expects it to bounce back in 2007.
"Stable interest rates and continued strength in the Hawaii economy should help both its real estate -- particularly commercial -- segments and its Hawaii shipping," Dole said.
"The company's advantage in real estate development is its lower-than-average cost of capital, primarily due to its strong balance sheet. Approval of the guide-rail system is positive for the Hawaii construction industry -- long term. The China shipping venture also seems to be doing better than expected."
Caris, whose firm covers A&B and has a "below average" rating on the stock, is negative on the company and cautious on the overall market. He expects the market to be flat to down 5 percent on the year.
"Technology will likely have a weak first quarter, and a strong second half," Caris said. "We would likely add to tech stocks later in the year. We see no recovery in the housing sector, particularly California and Hawaii, which points to further weakness for local real-estate/shipping concern Alexander & Baldwin."
Caris, who is keeping $8,243 -- or more than 41 percent -- of his hypothetical portfolio in cash, only chose three companies. Two of them are holdovers from last year -- optical supplier Oakley and Hawaiian Holdings Inc., the parent of Hawaiian Airlines that is coming out with earnings on Tuesday. His new addition is LSI Logic, which designs semiconductors for computer storage and DVD players.
"LSI has the opportunity to enjoy tremendous revenue synergies from its recent acquisition of Agere Systems as well as expense synergies that should tremendously improve the company's profitability," Caris said. "CEO Abhi Talwalkar (formerly of Intel) is a great manager and should be able to fully realize all the benefits of the acquisition."
Melton, who was crushed last year (a 19.9 percent decline) with his growth-momentum stocks, expects to bounce back in 2007.
"We're probably looking at a slow first half, in which GDP growth does not exceed 2 percent," he said. "Indeed, growth could fall shy of that modest level for a time should the slowdown in housing further intensify.
"It is possible that other economic areas, notably the capital goods sector, will retain enough strength to keep a serious economic slowdown or even a recession at bay for the first six months of 2007. A pickup is likely after midyear, when the recent decline in mortgage rates and the selective softening in home prices will put a floor under housing demand."
Among Melton's picks, he opted for two foreign exchange-traded funds -- one from China (the iShares FTSE/Xinhua China 25 Index Fund) and the other from Mexico (iShares MSCI Mexico Index Fund) -- as well as Core Laboratories, an oil field-service company based in Amsterdam, the Netherlands.
His other choices were apparel manufacturer Guess and Immucor, a manufacturer of medical diagnostic equipment.
Melton said Core Laboratories' profits are "racing ahead" and that the company has developed a popular lineup of products and services during a period in which the oil and gas-drilling companies it serves are loaded with cash to spend.
He likes Guess because of widening profit margins and a new operating system that is helping the company to control corporate expenses and better manage its inventory position.
As for Immucor, he cites improving margins, growing revenue and an updated computer system that "is likely to get technicians results faster and ... offer easier-to-use software."
Best investment ideas of 2007
Hawaii stock experts began the year with a $20,000 hypothetical portfolio:
FIM Group Ltd.
Position: Vice president of management team
2006 return: +19.5%
||2006 TOTAL RETURN
|iShares Lehman 1-3 Year
||Treasury Bond Fund
|Mitsubishi UFJ Financial Group
||Double inverse Nasdaq-100
Dole Capital LLC
||2005 TOTAL RETURN
||Scientific and technical instruments
||Aerospace / defense
||Medical / drugs
|Alexander & Baldwin
||Ocean transportation / real estate
Caris and Co.
Managing director for institutional sales
||2005 TOTAL RETURN
Hawaii Stocks and Options Group
||2005 TOTAL RETURN
||Oil / field services
||Medical diagnostic equipment
|iShares China 25 index
* Debuted on July 13, 2006; ** Cash will receive the highest rate listed by Bankrate.com, AmTrust Direct (5.36%), at the start of the quarter