Stack's Stocks

02/25/2005 12:00 am EST

Focus:

James Stack

President, Stack Financial Management

Combining exceptional technical and fundamental skills, market historian Jim Stack draws on lessons from the past in his analysis of future market trends. Here, he looks at the state of the market, its likely path, and the top stocks to play these trends.

"The good news for investors is that it is still a bull market. Intrinsically, we have the ingredients in place for a bull. Historically, interest rates are still low, even after six discount rate hikes. Rates are still in the lowest 10% of short-term interest rates that we have seen over the last 50 years. In other words, short-term rates have been higher than they are today in 90% of the time.

"The other good news is that both from a breadth and leadership standpoint, this is still a bull market. On most trading days recently, there have been fewer than ten stocks hitting new yearly lows on the NYSE. That is a striking characteristic of a healthy bull market. The bad news is that interest rates are rising. And the ugly news is that once interest rates start rising, if we see any surprises in the year ahead, it will likely be to the upside in inflation. And historically, nothing has killed more bull markets than upside surprises in interest rates.

"Meanwhile, this economic recovery is now 3.2 years old. Unfortunately, the median recovery length of all economic expansions of the past century is 3.1 years. The longer expansions of the 1980s and 1990s were more an aberration, than the norm. In addition, this bull market started in October of 2002 and is now 2.2 years old. The median life span of all bull markets over the last 75 years is 2.6 years. Now that doesn’t mean that the bull market is just going to end in a few months. But it does suggest that we're most likely in the latter portions of this bull market, and investors should adjust their portfolios accordingly.

"I would not expect energy prices to fall back to the $30s until the next recession. Over the balance of this year, I think you’re going to see oil remain in a higher trading range, which offers a good profit opportunity for energy stocks. In our managed accounts, we still have over twice the allocation to energy that you would see in the S&P 500 index. We have about a 15% energy allocation, which is one of the reasons why our accounts were up some 15% last year, even though we increased our cash positions during the year.

"I would also note that almost all the new power plants that are coming on line in North America are natural gas fired. So it means that the prices on natural gas are going to be less susceptible to the oscillations we will see in the price of oil. For those with a  conservative bias, I would look at domestic energy producers such as Devon Energy (DVN NYSE), with its exposure to natural gas. I would also suggest Encana (ECA NYSE), which is the largest independent natural gas producer in North America.

"I also think the big pharmaceutical companies now offer a contrarian opportunity. Nobody wants to touch them after the Vioxx scares and fears of regulation in drug prices. Yet if you look at many of these companies, they are selling at price to cash flow levels that we haven’t seen in two decades. If you want a conservative investmentone that really has potential for good double-digit gains, even in a rising interest rate environment look at some of the big pharmaceuticals. In particular I like  Abbott Labs (ABT NYSE) and Pfizer (PFE NYSE). When you compare the upside potential to the downside risk, I think these stocks provide some of the better trade-offs available in the market today."

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