Catching the Next Wave


Now that the presents have been opened (and returned) and the New Year’s resolutions made (and broken), money managers will troop back to their offices tomorrow for the official start of the 1998 investment season with two big questions on their minds.

How will I make money this year? And how will I keep from losing it?

Sure, they’re coming off three straight years of 20%-plus gains, but investment pros are girding for a less friendly 1998.

With profit growth in jeopardy as the Asian financial crisis does a slow boil, Wall Streeters want stocks that can churn out solid, if unspectacular, earnings. Most important, they want ones that won’t disappoint.


“In general, most of us would be very happy with a modest up year,” said Bob Smith, manager of the T. Rowe Price Growth Stock Fund.

Besides Asia and earnings worries, money managers expect several other major issues to hold center stage among investors this year: the continuing pace of mergers, the further restructuring of large companies and the march toward a single currency in Europe.

How these issues play out will go a long way toward determining the fate of the market this year. The Times spoke to several money managers last week to get a sense of how they plan to balance on each of these economic waves in the new year.


Most Wall Streeters remain extremely nervous about Asia. In the best-case scenario, they say, the region will stabilize this year and lay the groundwork for economic improvement in the future. That means individual investors trying to bottom-fish should be patient and careful.

For people who think the worst is over, closed-end country funds may be the way to go. Closed-ends are professionally managed mutual funds, most of them traded on the New York Stock Exchange. They eliminate the need to pick specific securities and give some measure of protection should things get worse.

About three dozen closed-end funds focus on Asian countries such as China, South Korea, Japan and Indonesia.


But be warned: For a brief time in early December, when it appeared that Asia had turned the corner and its battered stock markets would recover, several closed-ends notched strong gains. The three Korea funds, for example, surged between 16% and 23% over two days. But when new problems erupted, they quickly dove.

For investors who want to try individual stocks, keep in mind that many U.S. and foreign companies could choose to sacrifice profits at their Asian operations this year to gain market share, said Hugh Young, manager of the Phoenix-Aberdeen New Asia Fund.

“Provided it doesn’t destroy the balance sheet next year, it’s really not about earnings,” he said. “It’s getting your name well-known, taking over the opposition and building up your base.”

Young likes the American Depositary receipts of Philippine Long Distance (ticker symbol: PHI) and PT Indosat (IIT), the Indonesian phone company.

“They’re both very solid companies,” he said. “They’re market leaders that are well-managed and dominate their local markets.”

He also suggests Pohang Iron & Steel (PKX) in South Korea. Steel is priced in U.S. dollars no matter where in the world it’s sold, Young said. That’s a crucial fact given the scramble many Korean companies have undergone lately to pay off dollar-denominated short-term debts.


Young and several other fund managers own HSBC Holdings (HSBA), the parent of Hong Kong & Shanghai Bank, the biggest bank in Hong Kong. Investors have fled Hong Kong lenders because of the region’s huge debt problems and fears that the drop in Hong Kong real estate prices will mean problem loans for banks. But HSBC has interests throughout the world, not just Hong Kong, and also has cash to gobble up weaker institutions, fund managers say.

The region’s financial problems mask the fact that “there are still a great many wealthy people in Asia” who continue to need banking services, Young said.

Rosemary Sagar, head of global equities at U.S. Trust Corp. in New York, believes the best way to play Asia is to stick with dominant global companies that can withstand the shock waves of the crisis.

She and others favor American International Group (AIG). The New York-based insurance giant underwrites policies in about 130 countries. The Asian woes shouldn’t hurt AIG too much because its insurance policies double as savings vehicles in many Pacific Rim countries, Sagar said. With no Social Security, people will keep buying policies, she said.

Sagar also recommends Sony (SNE)American depositary receipts. Although Japan is troubled, Sony has big sales in Europe and the United States, with a lot of its production in Southeast Asia.

Also, many of its products have unique features. “Their technology is differentiated enough so that they’re not going to be hurt by product deflation,” Sagar said.


Sony is 12% off its Aug. 1 high of $103.25, but is up 18% in the last seven weeks.

“Considering what’s been going on [in Asia], it’s been holding its own,” Sagar said.

T. Rowe Price’s Smith recommends clothing companies Warnaco Group (WAC) and St. John Knits (SJK). Neither company has any international exposure, he said, but each might be helped by Asia because of reduced manufacturing costs.

“These are companies that are hitting their numbers, are growing 20% and have great balance sheets,” he said.

Earnings Growth

If the bull market of the last 15 years had to be summed up in just two words, it would be “earnings growth.”

“Growth in ’98 will be tough from a U.S. equity perspective,” said Bob Bissell, chief investment officer at Wells Capital Management in Los Angeles.

Despite profit jitters on Wall Street, it’s important to remember that earnings aren’t expected to decline this year. The U.S. economy remains strong, as do several in Europe. And some experts think laggards such as France and Germany could pick up.

The danger, though, is that earnings growth rates could slow. That’s an unappetizing thought, considering there’s little room for disappointment at the market’s lofty valuation levels.


“Going forward in the world we live in, you want big-cap category killers with strong managements, leadership positions in their industries, strong balance sheets, good cash flow and consistent earnings,” said Charlie Mayer, who runs the Invesco Industrial Income Fund.

Mayer has been buying local phone companies, whose earnings are being helped by families putting in additional lines for children and Internet-linked computers.

He owns Bell Atlantic (BEL), which bought Baby Bell sibling Nynex last year; SBC Communications (SBC), which bought Pacific Telesis last year; and GTE (GTE).

“These companies continue to put up 10% earnings growth and a 3% or 4% dividend yield, so the total return isn’t bad,” Mayer said. “And people forget about the ancillary businesses they have, which are very profitable.”

He also has food companies Quaker Oats (OAT), Kellogg (K), General Mills (GIS) and H.J. Heinz (HNZ).

“You’ve got some pretty consistent earnings coming out of those companies,” Mayer said.

T. Rowe Price’s Smith likes several money-center banks, figuring they can cut costs as mergers continue and will be helped by low interest rates.


“If you look at a Chase (CMB) or Citicorp (CCI), they’re still pretty cheap,” Smith said. He also likes NationsBank (NB) and First Union (FTU), both of which have been scooping up competitors at a furious pace.

He’s also been finding bargains among battered technology companies. The key in tech is to buy companies whose products will remain in demand regardless of the economic environment. It’s also important to determine how many of a company’s products are manufactured and sold in Asia. Because of the international currency picture, it’s desirable to produce in Asia and sell elsewhere.

Smith is staying away from semiconductor-related companies. But he finds Compaq Computer (CPQ) intriguing at the moment.

“I don’t think their earnings have changed too much” because of Asia, he said.

Some investors have been frightened away from personal computer makers because of worries about slowing sales growth rates and the advent of so-called network computers that retail for less than $1,000. But Compaq is growing two to three times faster than the overall PC market, Smith said. Its nascent computer server business, which has much larger profit margins, also looks successful, he said.

“They can probably still grow [sales] 15% to 20%, if they can’t grow [them] 20% to 25%,” Smith said. But the stock is trading at 15 times estimated 1998 earnings.

Smith also likes BMC Software (BMCS), whose products manage databases on mainframes and huge computer networks. The company has recently told analysts it will meet sales expectations for the quarter ended in December. Two others Smith likes: EMC (EMC), which makes data storage software, and Network Associates, the company that was formed by the merger of McAfee Associates and Network General. Network Associates makes anti-virus computer software that will be needed even if the Asian or U.S. economies tank, experts say. It’s pricey at 31 times estimated 1998 earnings. But earnings are projected to grow 39% this year.


Steve Colton, manager of the Phoenix Growth & Income Fund, also is a fan of Network Associates. “That’s the kind of thing people would still be spending money on,” he said.


Despite the staggering number of mergers in the last two years, many investment pros think there are plenty more to come. And in the words of Wells’ Bissell: “If growth is very hard to find, the pressure for mergers will be higher than it was in the past.”

Several fund managers expect insurance companies to start devouring one another, just as banks have for several years. The industry is overcapitalized, and companies sell at lower valuations than banks.

“The insurance industry is several years behind the banking industry,” Bissell said.

He likes AIG, which has quietly been buying up many smaller rivals. It’s done a good job integrating its purchases, he said. Invesco’s Mayer also likes insurers as a merger play. His picks: Chubb (CB), Allmerica Financial (AFC), Lincoln National (LNC), Ohio Casualty (OCAS) and Travelers Property Casualty (TAP).

Restructuring and Turnarounds Allen Wisniewski, manager of the Stagecoach Diversified Equity Income Fund, likes three companies that could show nice gains if they succeed in revamping their operations.

The first is Waste Management (WMX), a onetime Wall Street darling that’s now in turmoil.

But the company has strong cash flow, the chance to grow through mergers and the likelihood that it will pick up business as municipalities out-source their garbage collection, Wisniewski said.


“It’s certainly not going to be the growth company it was 10 years ago, but it has growth possibilities going forward,” he said.

Wisniewski also likes PepsiCo (PEP), which recently spun off its restaurant operations. It’s now free to focus on its core beverage business and expand aggressively overseas to compete against Coca-Cola.

Finally, he recommends Eastman Kodak (EK), which has been battered lately by investors worried about its high costs and mounting competition from rival Fuji Photo Film. But Kodak just announced it would expand the number of jobs being cut in a previously announced downsizing. It has a strong franchise name and promising products, Wisniewski said.

“It’s definitely a show-me stock right now,” he said. “But if it can show positive news, which will take time, it will have a positive upside.”

T. Rowe Price’s Smith suggests health maintenance organization shares, which have tumbled out of favor with investors.

“Every company has missed earnings, [but] every company has focused on margins instead of market share, and every company is raising prices,” he said.


Boosting prices between 3% and 6% should help the bottom line, but could cost HMOs some customers. Nevertheless, slightly better results could sway sentiment on Wall Street, Smith said. His picks: United Healthcare (UNH) and Aetna (AET).

“Not a lot would have to happen for the group to move 180 degrees in terms of perception,” he said.


It’s too soon to tell how Europe’s drive toward a single currency will turn out, but investors already are looking at which companies will emerge as winners.

U.S. Trust’s Sagar likes Paris-based AXA-UAP (AXA), which is the second-largest insurance company in the world. It owns almost two-thirds of Equitable Co., which, in turn, holds a large stake in U.S. brokerage Donaldson, Lufkin & Jenrette. AXA-UAP is likely to benefit from the shift toward private pensions in Europe.

“They’re not well-known name-wise,” Sagar said, but the company is growing quickly through acquisitions.


Looking Forward

Money managers are bracing for a tough year in 1998. They want companies with strong balance sheets, leading positions in their industries and dependable earnings growth outlooks. Some of their picks for the new year, ranked by projected earnings growth:



Ticker Est. ’98 Est. ’98 earnings Company symbol P/E * growth rate Archer-Daniels-Midland** ADM 17.3 89.4 Network Associates NETA 30.3 38.9 BMC Software** BMCS 31.4 36.6 Compaq CPQ 21.1 26.5 EMC Software EMC 26.5 26 Payless Shoe Stores** PSS 20.3 23.5 United Healthcare UNH 22 23 PepsiCo PEP 31.9 21.1 Household Intl. HI 19.7 20.8 Warnaco Group WAC 17 20.4 St. John Knits** SJK 16.7 18.9 Kodak EK 17.4 18.3 Chase Manhattan CMB 13 17.8% All America Fin. AFC 15.3 17.5 Dow Chemical DOW 13.3 15.1 AlliedSignal ALD 18.7 15 Waste Management WMX 18.5 14.8 Sherwin-Williams SHW 18.5 14 AIG AIG 23.6 13.5 First Data FDC 19.3 13.2 ConAgra** CAG 21.9 12.7 Citicorp CCI 14.9 12.6 Chubb CB 18.5 12.5 Lincoln National LNC 17.4 11.6 Aetna AET 16.6 8.5 HSBC Holdings HSBA 12.1 8.4 Philippine Long Dis. PHI 15.4 N/A PT Indosat IIT 17.7 N/A Pohang Iron & Steel PKX 11.8 N/A AVA-UAP AXA 20.8 N/A


*Price-to-earnings ratio

**Fiscal year does not end Dec. 31.

N/A: Not available

Sources: Bloomberg News, IBES