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"Directions" from Davis

02/25/2005 12:00 am EST


Ned Davis

Senior Investment Strategist, Ned Davis Research

Ned Davis, senior strategist at Ned Davis Research, is an exceptional analyst; I've been a fan of his work for many years. He uses computer-based models to assess the financial spectrum from global economies and markets to currencies, sectors, and individual stocks.

"In 2002, the world was on the brink of a deflationary accident and at that point in time, world central banks decided to stimulate very aggressively, and cut interest rates. As you know, the Fed had cut rates 13 times all the way down to 1%. I think that the 1% level was the key to everything else that has gone on since. From there, the Fed was able to stimulate and get things going again. But because there was so much slack in the system, they were able to stimulate without really any increase in inflationary pressures.

"Now, the Fed has started raising rates, having just gone to 2.5%. We’ve found that at a Fed funds level of 2.5% or below, the market typically goes up about 15.5% a year. So even though I don’t like the direction of short-term interest rates, they are still low enough at this point where they are not yet biting to the market. I would caution, however, that a move in long rates to 4.75% to 5% on T-bonds would be a problem. We got up to that level very briefly last July and the market struggled. There is $36 trillion in credit market debt and if rates rose to that area, it would start to be painful. So that is what I’d watch. But for now, as long as bonds behave, the stock market should be given the benefit of the doubt.

"I also key in on the markets themselves. We follow 42 international markets and all 42 are above their 40-week moving average. That means they are in uptrends. As long as most markets are in uptrends, we are in a bull market. If that percentage were to drop to 60%-65%, that would suggest enough of loss in momentum that I would get concerned. But again, for right now, the trends are still up and things look pretty good. Another factor to know is that bull markets generally last on average two to two and a half years. The bull market since October of 2002 is already over 2 years, so we are in the late innings.

"As for particularly investments, I like to buy group sector funds. We currently suggest the iShares MSCI South Africa (EZA ASE). In Europe, I like the prospects for iShares MSCI Austria (EWO ASE) and iShares MSCI Belgium (EWK ASE). Finally, I would look at healthcare, which we consider a growth area. We would suggest the Fidelity Medical Delivery Fund (FSHCX ).

"Meanwhile, our favorite sectors domestically have been energy and materials. Globalization, including the boom in China and India, has set off important macro events. While those regions have cheap labor, they are not rich in raw materials. This has set off a boom in many emerging markets. As a result, we particularly like Latin America and the emerging markets in the Pacific Basin area. We would suggest Fidelity Latin America (FLATX ) and iShares MSCI Brazil (EWZ ASE). We think they are a play on worldwide reflation and the boom in China.

"I'd also comment on the utility sector, primarily because of their dividends. We recently did a study going back to the 1970s on stocks in the S&P 500. The record is dramatically positive for companies that pay dividends,  especially so for those that are increasing their dividends. We then did another study to see what sectors do well in the late phases of a bull market and the early phases of a bear market. We found that in the early phases of a bull market people are speculative and they like growth stocks. But when you get later in a bull market, it switches more towards dividend paying stocks. So right now, we really like the ‘back to dividends’ theme."

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