Bulls versus Bears

Dave Ebner 04:51 EDT

Saturday, October 28, 2000

October, that dark month of devastating crashes, has once more lived up to its reputation. The question, however, is what’s next? And, more importantly, what should investors do to ensure the best returns in what could either be a strong or weak market?

The past month, in terms of volatility, has been extreme. Just this week the Toronto Stock Exchange composite took a massive dive, plunging 8.1 per cent on Wednesday when investors suddenly lost faith in up-to-then invincible Nortel Networks Corp. The day’s decline was, in percentage terms, the exchange’s second worst ever, not far behind 1987’s Black Monday. The 840.26-point loss went on the books as a new record.

In the weeks before, the Nasdaq Stock Market commanded the spotlight on the stomach-churning stage. On unlucky Oct. 13, a Friday, the technology-heavy index soared, scoring its second-largest percentage jump with a 7.9-per-cent gain. Then, three sessions later on Oct. 18, the composite sank 5.8 per cent in the 15 minutes following the opening bell. But Nasdaq recovered by lunch.

It’s a time when stocks seem prone to losing a quarter of their value in a single session, as Nortel, Apple Computer Inc. and others managed quite easily. The unfairly disparaged notion of asset mix investing a good chunk of your net worth in things other than stocks is beginning to make sense again.

Where the markets are headed, of course, is always a tricky question. As you might expect, there are two entrenched lines of thought.

The first the one of sunny optimism goes like this:

We’ve got positive fundamentals, over all, for equities, says Rohit Sehgal, Toronto-based Dynamic Mutual Fund Ltd.’s chief investment strategist and manager of $2-billion in domestic stocks. Given that, even though we’re going through a lot of volatility and negative sentiment right now, we think we can get some really decent returns from the markets going forward.

The second and not lesser view is one of considerably more angst:

There’s been a very definite slowing down of earnings growth and there will follow a substantial worsening of the earnings outlook for the next year, says Ross Healy, president and chief executive officer of Toronto-based consulting firm Strategic Analysis Corp. One sees a general slowdown in progress. I think a fundamental bearish trend will continue.

It’s a classic bull versus bear duel, a scrap that will decide the market’s direction after a decade-long expansion, one of the best runs in market history.

To help navigate a difficult course, The Globe and Mail has created two portfolios with the aid of six market professionals. (See below). One takes the view the markets are nearly finished with the current correction and North American indexes are poised to grow once more. It’s aggressive and targets high-growth companies. The other sees nothing but a brewing storm and goes heavy on fixed-income bonds and rock-steady equities.

www.globeinvestor.com. You can find our duelling portfolios there, with a daily update of how they are faring. May the best bull or bear win.

The Defence

Ricky Harrington wants to clear something up.

The public needs to understand that this is not as good a market as the averages of the SP, the Dow and the Nasdaq might have you think, says Mr. Harrington, a technical analyst and senior vice-president at Wachovia Securities in Charlotte, N.C.

I think we’ve been in a bear market for quite some time. Probably a majority or close to a majority of stocks peaked out in 1998.

Mr. Harrington sees three distinct problems with today’s markets. First, fundamentally, he says stocks are overvalued. Second, technically, market leadership is fragmented and the focus is on a handful of major names, which is an overall negative. Third, psychologically, Mr. Harrington believes the amount of money the general public has poured into the markets in the past 10 years means any drop in equities will affect the economy, further pushing equities down.

Looking ahead, Mr. Harrington says it’s not getting any better. He says earnings will continue to slow and the U.S. dollar’s dominance will be tested.

Waiting in the wings, I think, are currency fluctuations, he says. The dollar has been strong for a long time. If the dollar weakens, that’s going to create some problems that most people have not even thought about.

In such a hostile environment, the defensive outlook is going to favour fixed-income investments, says Ross Healy, president and chief executive officer of Strategic Analysis Corp.

In a bearish market, my immediate instincts would be to go for 100 per cent cash and short-term debt, he says, half-joking.

Equities, however, do have a place in our bears’ consensus: 40-per-cent stocks, 15-per-cent cash and 45-per-cent fixed-income.

Mr. Healy says in times of trouble, stocks with high yields in conservative sectors are the best bet.

I think that an almost dirty word in the business is dividends, he says. But it’s time to take a good hard look at dividend-paying stocks because it may be just about all you get for at least the next little while.

To that end, Mr. Healy’s list begins with mining and metals company Noranda Inc. of Toronto. Its yield is 5.7 per cent and it’s trading not far from a 20-year low, in valuation terms. That, combined with a nearly 6-per-cent yield, should take an investor through fairly safely.

Another high-yield stock is Montreal-based Reitmans (Canada) Inc. The women’s-apparel company’s yield is 4.85 per cent and it’s trading at a discount to its book value. It has a very strong balance sheet, Mr. Healy says, which’ll see you through just about anything.

The third in Mr. Healy’s trio of dividend-producing companies is Calgary-based TransCanada PipeLines Ltd.. which has a 5.6-per-cent yield. He says the company’s balance sheet is improving and notes demand for its services is unlikely to abate.

Mr. Healy’s last pick is something of a market hedge. Gold producer Barrick Gold Corp. of Toronto is trading quite close to 20-year valuation lows. It has good upside potential, he says. With a potentially weaker American currency, we will likely see stronger bullion prices, which would impact Barrick almost immediately. And if not if nothing in particular happens Barrick is so cheap that it’s not a stock that worries me on the downside.

Fred Pynn, vice-president of equities at Calgary money manager Bissett Investment Management, says the oil and gas sector still has more room to grow. There’s been no multiple expansion, he says. There’s no speculation in this sector. And the price of natural gas has staying power.

Mr. Pynn likes two Calgary companies: Alberta Energy Co. Ltd. for its natural-gas business and Canadian Occidental Petroleum Ltd. for its foreign exposure. (CanOxy becomes Nexen Inc. next month.

Mr. Pynn also says the banks, though pricier than they were six months ago, remain solid, offering high return on equity, good yields and prospects for future dividend increases. That makes a pretty compelling investment case, he says. His choice is Bank of Nova Scotia .

Wachovia Securities’ Mr. Harrington is a bond man: The bulk of a person’s investments right now should be moving into the fixed-income area.

Still, he does like a couple of equities. The first is Charlotte-based Duke Energy Corp.. which he says is well diversified and probably the best U.S. utility company.

Newmont Mining Corp. of Denver, a gold producer, is another equity on Mr. Harrington’s list. The fact that they’re industry leaders makes them more attractive than anything else.

Mr. Harrington’s last choice is real estate investment trust Summit Properties Inc. of Charlotte, which has a 7.6-per-cent yield and operates in a rapidly growing area of the United States, the Southeast.

The Offence

It may seem like the depth of market strife makes it somewhat difficult to picture a quick return to the days where the bulls ran free. But aggressive fund managers say that time is nearly here once more.

The market is fine here, says Bill Onslow, who manages about $600-million in U.S. equities for Toronto-based Altamira Investment Services Inc.

There’s been some short-term disruptions and concerns, primarily in the technology sector, which has been the real driver of the market and growth in the economy as a whole. But I don’t think there are fundamental issues. Once we get through this rocky period we’ll be okay.

The current environment is good for equities, Mr. Onslow says, citing the standard bullish arguments: Interest rates appear to have peaked; inflation is in check; the economy is slowing and will grow at a more reasonable pace; and productivity continues to improve.

Mr. Onslow says recent losses have created opportunities.

Given where the U.S. market has fallen to, it’s probably time to get a little more aggressive.

He is not alone in the bull camp.

To be aggressive, you should always be 100 per cent in equities, period, says Derek Webb, president and chief executive officer of Webb Capital Management in San Francisco.

I have 100 per cent of my liquid net worth in my funds. I always have. Because I know the stock market is the best vehicle to grow money. It always has been and I think it always will be.

Though Mr. Webb, who leads the management of seven funds for C.I. Fund Management Inc. is as aggressive as they come, the consensus of three bulls puts the recommended asset mix at about 80-per-cent stocks and 20-per-cent fixed-income.

As for the stock component, Mr. Webb’s first recommendation is Nortel Networks Corp. Hours before the company came out with its third-quarter numbers, which investors took so badly, Mr. Webb said: There’s huge earnings momentum there. And that’s his style, picking stocks that post big growth. The day of Nortel’s official meltdown Mr. Webb was still behind the company, saying it had lost a bit of its momentum but was much cheaper and still a buy.

For those that want exposure to electronic component manufacturer Celestica Inc. Mr. Webb suggests Onex Corp.. Celestica’s controlling shareholder.

General Electric Co. of Fairfield, Conn. is another pick, though at first it doesn’t seem to be that much of an offensive play. But Mr. Webb says GE’s acquisition of Honeywell International Inc. will add significantly to the top and bottom lines quickly.

The numbers are going higher, which is what we always want to see, he says. Numbers go higher, stocks go higher.

Natural gas is a hote sector, Mr. Webb says, recommending Calgary-based Anderson Exploration Ltd.

There is no OPEC in gas. I expect prices to remain high. There is no extra supply, and demand is very high.

Mr. Webb’s final choice is Britain’s Shire Pharmaceuticals Group PLC. a generic drug manufacturer. In the next five years, a number of drugs, including Prozac, go off patent, and Shire is one of many trying to take advantage of the trend. Shire’s American depositary receipts (ADRs) trade on the Nasdaq Stock Market.

Three popular sectors emerged as the offensive managers spoke: Health care, technology (specifically Internet hardware) and financials. Rohit Sehgal, chief investment strategist of Dynamic Mutual Funds Ltd. fingers an equity in each sector.

Finland-based Nokia Corp.. whose ADRs trade on the New York Stock Exchange, announced solid third-quarter numbers Oct. 19 and Mr. Sehgal says demand for mobile phones continues to grow. He also likes Nortel.

In health, Mr. Sehgal says Mississauga-based Biovail Corp. is a domestic health company ready to take advantage of the raft of drugs going off patent.

In Canada, he says, this is one stock that we have a pretty large position in.

Finally, Mr. Sehgal says there is a growing feeling the Canadian federal government will warm to the idea of consolidation in the financial sector next year and with Bank of Montreal trading around $70 it will be a sitting duck. Dynamic has a 12-month target of $95.

Altamira’s Bill Onslow, co-manager of the $162-million Altamira Health Sciences Fund, up 156 per cent in the year to Sept. 30, likes Amgen Inc. of Thousand Oaks, Calif. Amgen, a large, established biotechnology company, is a top holding in the successful fund. It’s not cheap, Mr. Onslow says, but it seems to be set for an acceleration in both sales and earnings.

Completing the 10 offensive equities is money manager State Street Corp. of Boston.

Duelling portfolios

We constructed two portfolios reflecting the views of our bears and bulls. Starting with $100,000, we spread the money across the three asset classes. The money earmarked for stocks $40,000 for the bears and $80,000 for the bulls was spread equally among the 10 picks. The portfolio will be updated daily on globeinvstor.com.

BEAR PORTFOLIO

Recommended asset allocation

40% equities $40,000

45% bonds $45,000

15% cash $15,000