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Dump high-fliers
as economy slows down,
analysts suggestTechnology and small-cap stocks
may be overextended after
the big run-up this year
NEW YORK >> As stocks reach levels unseen in nearly two years, experts are suggesting that investors consider dumping high-fliers such as tech and small-cap shares.
That's because when economic growth slows in 2004, the likely sector leaders in the new bull market may well be stodgier investments such as materials, large-cap and dividend-paying stocks.
"If you waited for Dow 10,000 as an all-clear to put money back in the market, that's a bad trading idea," said Robert Streed, portfolio manager of Northern Trust Select Equity Fund in Chicago. He noted that the top sector gainers this year likely will see tepid gains in 2004.
"Now they're overbought," Streed said. "Whether it's a simple valuation call or too many aggressive projections out there in terms of what the business can do, there's a high likelihood of fundamental disappointment."
The Dow Jones industrials crossed the 10,000 barrier this past week, powered by a batch of strong economic data and Federal Reserve comments suggesting higher interest rates weren't coming anytime soon.
It was a stunning recovery from a five-year low of 7,286.27 reached on Oct. 9, 2002, a date that turned out to mark the end of a grueling three-year bear market, as investors bet on an economic rebound once the war in Iraq winded down. The last time the Dow closed above 10,000 was May 24, 2002.
So far, the big winner in 2003 has been technology, with the Nasdaq composite index staging a remarkable 74 percent advance since the October 2002 bottom. Other gainers were sectors whose earnings is closely tied to the strength of the economy, including small-cap companies, which tend to grow quicker than larger, bloated companies; and consumer discretionary, such as retail, autos and homebuilders.
But analysts say that will change in 2004. In the middle stages of an economic recovery, growth tends to slow down from the previous year, providing a boon to less volatile companies such as basic materials, health care and energy.
Valuations for high-flying tech and retail stocks, meanwhile, appear to be a bit stretched after several months of strong gains, and thus might be due for more modest gains if not a pullback. In addition, those sectors will face tougher profit comparisons next year because of good performance in 2003.
"In the second half of '03, the market corrections were very modest, so you didn't get the nervousness on the part of investors," said Steve Young, chief investment strategist for Banc of America Capital Management.
"If corrections are bigger next year because we're not in an accelerating growth environment, investor anxiety may translate to more investments in bigger, high-quality companies," he said.
There were signs of a possible shift in sector leadership in recent weeks.
A week ago, the tech-focused Nasdaq composite index brushed the 2,000 milestone, but has since stumbled on investor concerns that valuations are a bit high. Indeed, the Nasdaq so far has a monthly loss in December, compared to gains for the other main gauges.
The Dow crossed 10,000 for all of one minute Tuesday, but then took just two days to close above that level Thursday. Analysts said much of the stock market's strength came from investors jumping in to pick up blue-chip shares.
Another winner in 2004 may be dividend-paying stocks. President Bush earlier this year signed a tax-cut package that trimmed the dividend tax, leading many to believe the more conservative investments would take off amid a sluggish economy.
The economy proved to rebound quicker than expected after the war in Iraq subsided, and higher-yielding but riskier growth stocks turned out to be more popular. However, as economic growth decelerates, the lure of stable dividend payouts could become more attractive.
In the end, analysts say there are stock opportunities across all sectors in 2004 for investors who carefully analyze share valuation, business trends and the quality of the company. Companies who set lofty expectations, meanwhile, will more likely disappoint.
"With the economy in gear and companies coming through with earnings and revenues, any company that doesn't deliver on its numbers is going to get murdered," Streed said.
The Dow ended the week up 179.48, or 1.8 percent, finishing at 10,042.16. The S&P 500 rose 12.64, or 1.2 percent, during the week, to 1,074.14.
The Nasdaq gained 11.18, or 0.6 percent, to close the week at 1,949.00.
The Russell 2000 index, which tracks smaller company stocks, ended the week up 8.58, or 1.6 percent, closing at 547.59.
The Wilshire 5000 Total Market Index, which tracks more than 5,700 U.S.-based companies, ended the week at 10,464.48, up 111.88 from the previous week. A year ago, the index was at 8,426.09.
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