Investors’ Views Suggest Shift on Economy : Industrial Shares Benefit From Dramatic Selloff in Consumer Issues : Quarterly Investment Outlook
Industrial stocks replaced health care issues as the market’s undisputed stars in the first quarter, a shift in investor sentiment that could have long-term implications far beyond the borders of Wall Street.
If the first-quarter trend continues, it could signal a new wave of investment in basic nuts-and-bolts American industry. It also could foreshadow serious cost cutting and downsizing in the health care business--Wall Street’s favorite for nearly 10 years, but now the target of increasing political and popular ire.
Admittedly, it’s usually dangerous to read too much into one quarter’s market moves. But the timing and degree of the first-quarter shift among stock groups suggests a sea-change in investors’ attitude toward the market and the economy.
On the surface, the stock market appeared hesitant and confused in the first quarter: The Dow Jones industrial average rose 66.64 points, or 2.1%, to close at 3,235.47; but the broader Standard & Poor’s index of 500 major stocks dropped 3.2%.
What those indexes mask, however, is a dramatic rally in industrial stocks and an equally dramatic selloff in health care issues and other consumer-related stocks. The catalyst for both moves was the growing belief that the recession that began in mid-1990 had finally ended:
* Auto makers’ shares have rocketed an average of 33.8% this year on expectations of a sustained rebound in auto sales. Ford Motor’s stock, for example, has surged 36% to $38.375.
Other industrial stock groups rising sharply included machine-tool makers, truck makers and producers of building materials.
* The quarter’s losers, meanwhile, were the stocks that many investors couldn’t seem to own enough of in 1991--mainly drug companies and other health care firms whose shares had risen 60% or more last year, on average.
Thousand Oaks-based biotech company Amgen Inc., the leader in its field, plunged 17% in the quarter, ending at $62.50.
At one level, Wall Street is just following the usual script when an economic recovery begins: Investors warm to the depressed industrial stocks whose earnings should rise as consumers and businesses begin to spend again on big-ticket items such as cars, homes, computers and machinery.
At the same time, the start of a recovery is usually when investors lighten up on the “safe” stocks that they held throughout the recession--drug firms, food producers and other makers of goods that typically enjoy stable demand in good times or bad.
The growing debate on Wall Street is whether the shift into industrial stocks and out of consumer stocks now is secular rather than cyclical--meaning, a trend that will deepen over the next few years, surprising most investors with its intensity.
The consumer stocks, especially the drug stocks, have been the market’s stars since 1984. Some analysts say that’s far too long for one group to lead Wall Street. Last year’s frenzy for health care issues--illustrated by the scores of initial stock offerings by emerging (and highly speculative) medical-product companies--had all the trappings of a final blowout, the stocks’ critics say. The decline won’t end with the first quarter, they argue.
Robert Rodriguez, who manages the $112-million FPA Capital stock mutual fund in Los Angeles, says he still wouldn’t buy biotech stocks, even after their first-quarter plunge.
The health care industry in general is under a “cloud” now, Rodriguez says, as the nation grapples with the question of how to bring down the outrageous cost of medical services. Maybe nationalized medicine will never arrive, but a growing number of money managers fear that some form of politically mandated limits on health care costs are inevitable. The implications for health care companies, and their stocks, would be onerous.
So even though the stocks have come down, their prices relative to earnings are higher than many professional investors are willing to pay. Says Rodriguez: “Their valuations require that nothing happens” in the form of price controls, and that’s not a bet he’s willing to make.
Ted Gomoll, who manages the $700-million G.T. Global Health Care mutual fund in San Francisco, naturally disagrees. He’s not surprised that some investors took profits in medical stocks in the first quarter. He wouldn’t be surprised if the stocks slumped for a few more months.
But Gomoll notes that some of the brightest stars in the industry are the solution to rising medical costs, not the cause--for example, booming surgical centers that perform once-expensive hospital operations on an out-patient basis.
The bottom line, says Gomoll, is that many health care companies will continue to produce double-digit earnings growth over the next few years. So how can anyone suggest that their stocks will languish for years? he asks.
Gomoll has a good point: The stock market isn’t a universe of absolutes--there are lots of shades of gray. Not all health care stocks will crash. Not all industrial stocks will rise from here.
But investors’ perceptions at any given point are as important as reality. And for now, it appears, those perceptions favor the long-ignored industrial issues.
Money managers such as Rodriguez, for example, are eagerly ferreting out industrial companies that should benefit from even a small rise in demand for their products, as the economy climbs slowly out of recession. Two of his recent purchases: Thor Industries, a maker of motor homes, and Oregon Steel, a profitable mini-mill operator.
Morgan White, who manages $100 million at Woodside Asset Management in Menlo Park, agrees that many of his peers are of the same view: It’s time for a change in market focus. The stock market overall, he notes, is likely to struggle this year, even as the economy recovers. The reason is that a recovery often brings with it a rise in interest rates, which causes investors to reconsider what they’re willing to pay for stocks.
In that kind of environment, White says, you want to own stocks that are reasonably valued relative to earnings, and which also hold strong promise of accelerating earnings. The best place to search for stocks that fit both of those requirements, White says, is in the industrial arena, not among the classic consumer growth stocks of the 1980s whose earnings growth is predictable.
Two industrial issues that his firm purchased late last year are Briggs & Stratton, which makes small industrial engines, and Whirlpool, the home appliance giant.
It’s also true, though, that the first-quarter gains in many industrial issues already discount a decent profit recovery this year. To buy now, you have to be looking ahead to what the companies might earn in 1993 and beyond. Obviously, that is a leap of faith about the economy, and it requires patience.
But patient investing has made a lot of money for its practitioners over the years, and nothing has yet happened to suggest that concept has been repealed.
Stocks: A Struggle With Success In the first quarter, more investors came to believe that the economy is successfully emerging from recession. So Wall Street snapped up industrial issues, while dumping health care and other “safe” growth issues. But the economy’s “success” also sparked higher interest rates and a rush of new share offerings. End result: a stalled stock market.
As industrial stocks roar Ford Motor weekly closes, except latest. January 3: $30.38 March 31: $38.38
. . .health care stocks fade... Amgen Inc. weekly closes, except latest. January 3: $74.25 March 31: $62.50
. . .and the broad market stalls Dow Jones industrial average weekly closes, except latest. January 3: 3,201.48 March 31: 3,235.47 Source: Los Angeles Times
First Quarter’s Best and Worst Stocks How stocks in key industry groups rose or fell, on average, in the first quarter:
Biggest Gainers
Average pct. change: Stock group 1991 1st qtr. Machine tools +20.7% +38.3% Electronic instruments +69.6% +35.7% Auto makers -8.0% +33.8% Entertainment +7.9% +27.1% Manufactured housing +41.6% +26.2% Major banks +48.9% +25.0% Trucks/truck parts +24.8% +20.9% Hardware/tools +31.5% +20.6% Transportation (misc.) +21.2% +19.8% Building materials +38.0% +17.5% S&P; 500 index +26.3% -3.2%
Biggest Losers
Average pct. change: Stock group 1991 1st qtr. Medical products/supplies +60.7% -16.1% Health care (misc.) +68.6% -15.7% Hospital management -15.5% -13.6% Drugs +62.4% -13.5% Food producers +42.5% -12.6% Diversified health care +43.6% -12.6% Telephone utilities +0.7% -12.5% Gold mining -25.2% -12.3% Insurance (multi-line) +30.0% -12.0% Oil well equipment -5.3% -11.0%
Group data through Monday.
Source: Smith Barney, Harris Upham & Co., using S&P; indexes
