Conventional wisdom holds that when interest rates are coming down, investors should start buying into companies that are either interest-rate sensitive, like financial stocks, or benefit from the shot in the arm the economy gets from lower rates, such as retail and technology.
But that doesn't mean investors should go out and start blindly buying these sectors, even if the market has beaten them down. Although many fund managers see continued Federal Reserve rate cuts helping the slowing economy this year, earnings disappointments are still expected to haunt many companies during the first half of this year, and fund pros are carefully picking and choosing their spots.
"You really want to stick with the better stocks," says Chris McHugh, senior portfolio manager at Turner Investment Partners. "You want to be with the market leaders versus just buying some of the stocks that look cheap on valuation."
McHugh, co-manager of the Turner Technology, Turner Wireless and Technology and the Turner B2B E-Commerce funds, says he sees some attractive opportunities among the more established Internet storage, software, fiber optics and B2B companies.
McHugh says he's focusing on firms he thinks will benefit from brick and mortar companies' efforts to develop their technology to improve efficiency. Though the next few months could be rocky for these stocks, McHugh says he sees light at the end of the tunnel for more established tech companies later on this year, especially as lending rates tick down and companies find funding their tech efforts less costly.
"Companies that all help out within the supply chains will see significant growth over the next couple of years," says McHugh.
Among the names McHugh likes include Internet software company Mercury Interactive, storage companies Brocade and EMC, and B2B software developer I2 Technologies.
Abel Garcia, portfolio manager of the AIM Global Telecom and Technology fund agrees that some tech companies will benefit in the new environment. He sees value in firms like fiber-optics parts maker JDS Uniphase and B2B applications provider Siebel Systems.
"It's a good time to buy, because we are down so much and everybody is so negative," says Garcia. "I don't know if we have total capitulation, but it sure feels like it."
However, one tech area that Garcia is decidedly not bullish on is the personal computer makers, for which he, like many analysts, thinks the market is pretty much saturated.
The Right Financials
Not everyone is jumping on the tech bandwagon, however. Some fund managers are delving into the more traditional beneficiaries of rate easings like financials and retailers, while other managers say there are some attractive offerings in the health-care sector.
Knight prefers commercial banks like Dime Bancorp and Sovereign Bancorp, which he thinks will benefit from increased lending activity, and asset management companies like Waddell & Reed and Legg Mason which should get a boost if the Fed's rate moves prompt people to put more money in the markets.
The fund skipper is not bullish on all commercial banks. While he declined to name names, he says investors should be careful to choose companies in the sector that will not be affected by deteriorating credit quality. Relaxed lending standards in recent years have come back to haunt banks like Bank of America, Wachovia and Bank One in the past few months.
Knight is also decidedly not bullish on the brokerages, which he thinks will continue to suffer from what he expects to be a lackluster initial public offering market.
"A lot of their earnings comes from investment banking and I think that's dead for most of this year," says Knight.
Not everyone agrees with Knight on that front. Mark Halperin, manager of the Federated Global Financial Services fund, says he expects the Fed's rate moves to stimulate investment banking activity and predicts that 2001 will see a slew of deals getting done, which would be a boon for brokerages like Raymond James Financial, one of his fund's top 10 holdings.
And though Halperin agrees that asset managers are a good place to be (one of his fund's largest holdings is Stillwell Financial, parent company of Janus), he is avoiding regional banks.
"I don't have as much exposure in regional banks, because loan growth is slowing and a lot of these banks are making earnings by taking their provisions down," he says.
On the health-care front, both Knight and Michael Yellen, manager of the AIM Global Health Care fund, are big fans of health-care service providers, especially hospitals.
More than half of the top 10 companies in Yellen's fund are hospital groups like Tenet Healthcare and Quorum Health Group.
"I like the hospitals because not only are the fundamentals solid, but in fact, they're improving," says Yellen.
Yellen says that while he expects most of the pharmaceutical companies to make their numbers in 2001, he doesn't expect the outperformance the sector showed in 2000, a phenomenon that he attributes in large part to a rotation out of tech stocks. He is also cautious on many biotech names, which he considers somewhat speculative.
As for retail, some investors, like Craig Callahan of the Icon Consumer Discretionary fund, says though more bad news could be on the horizon for the sector, he believes that is already priced in to many retail names.
He mentions electronic retailer Best Buy and discount chain Family Dollar as examples of companies that could be heading higher.
"We would expect the stocks to move well ahead of and even during the bad news," says Callahan.