Risk Is Back, but Where Is Return?

02/06/2008 12:00 am EST


Joe Battipaglia

Market Strategist-Private Client Group, Stifel Nicolaus

Joe Battipaglia, market strategist for the private client group of Stifel Nicolaus, is cautious for the immediate future but more optimistic over the long run.

Joe Battipaglia predicted that the housing recession will continue into next year, and home prices will continue to fall. The unemployment rate-currently around 5%-will most likely rise to 6%, he said. And consumers will reorient their personal income to paying down debt vs. incremental spending on big-ticket items.

So, Americans' worry about the value of their biggest asset-their homes-is causing a sea change in their attitudes. They are scrambling to figure out a new financial equation for their households and changing the way they actively behave, including reducing spending and the amount of debt they are carrying.

And since 70% of gross domestic product (GDP) is related to consumer spending, this has resulted in a weaker economy. Battipaglia said banks will have more write-offs coming along, homeowners will continue to walk away from properties they can't afford, millions of others will attempt to find alternative financing, and the regulators will try to do everything humanly possible to move the process along.

But they will not be able to accelerate the process; the best thing for them to do is to get out of the way and let it happen. Battipaglia said we are about two-thirds of the way through the credit contraction.

Last year, his firm invested a lot of its customers' capital in investment-grade debt issues, which performed beautifully.  He said he is finding opportunities in beaten-down high-yield bonds and real estate investment trusts (REITs), both of which did poorly in 2007 after several years of strong performance. Now, the typical REIT is paying 2.5 percentage points more than Treasuries; he is looking for REITs with extra cash flow that have a long track record.
Battipaglia also said stocks were much more attractive than they were a year ago. He told attendees that market cycles have three parts:

1. Disbelief, when the first signals appear that something is wrong
2. Tough times (like now), in which employment shrinks, banks are under duress, and manufacturing is slipping.
3. Recovery, in which banks take write-downs, low rates take hold (in 2009 and 2010), oil prices decline-maybe to $60 to $70 a barrel, and the economy rebounds.

Battipaglia said 55% of his recommended portfolio is allocated to stocks, of which 41% are domestic and 14% international issues, with an emphasis on income and defensive stocks. He is focusing on large- and mid-cap stocks with strong balance sheets, good cash flow, diversified revenue sources, and margins that they've maintained for at least three years.

He also said he favors growth stocks over value, and that he likes technology, consumer staples, health care, telecom and parts of the industrial complex.
Battipaglia closed his workshop with specific recommendations, including:

Industrials: 3M (Nyse: MMM), General Electric (Nyse: GE)
Transports: Burlington Northern (Nyse: BNI)
Consumer: Kraft (Nyse: KFT), Kimberly-Clark (Nyse: KMB), Reynolds American (Nyse: RAI)
Healthcare: Lincare (Nasdaq: LNCR), Johnson & Johnson (Nyse: JNJ)
REITs: Weingarten Realty (Nyse: WRI)
Technology: eBay (Nasdaq: EBAY), Microsoft (Nasdaq: MSFT), Palm (Nasdaq: PALM)
Financial services: Wachovia (Nyse: WB), PNC Financial (Nyse: PNC)
Telecom: AT&T (Nyse: T) and Verizon (Nyse: VZ)

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