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Local pros optimistic, with reservations

By HELEN HUNTLEY, Times Staff Writer

© St. Petersburg Times
published January 5, 2003

What's ahead for investors in 2003? Times personal finance editor Helen Huntley sat down with three Tampa Bay area investment pros to find out their views. Participants in the conversation were:

-- David Henwood, 61, chief investment officer and supervisor of equity research at Raymond James & Associates, St. Petersburg. Henwood is a chartered financial analyst with an MBA degree from the University of Michigan.

-- Gloria Blackburn, 51, chairwoman of the investment committee at Premier Investment Management, Clearwater. Blackburn is a certified public accountant and has an MBA degree from Florida Institute of Technology.

-- Timothy McIntosh, 38, senior partner and chief investment officer of Strategic Investment Partners in St. Petersburg. He is a certified financial planner and an adjunct professor of finance at Eckerd College. He has an MBA degree from the University of Sarasota.

Here is an edited transcript of what they had to say:

Huntley: The economic recovery has been slower to take hold than many people had hoped. I'd like to hear your thoughts about how the economy is doing. Are we out of the woods yet?

Henwood: We're in a period of a decelerating growth from the 4 percent GDP you had in the September quarter. We think you're going to see GDP a lot slower in December. A lot of factors are involved in the slowdown, the biggest being weaker consumer spending. The first half expectation (for) the U.S. economy is about 21/2 percent GDP growth rate and about 3 percent growth in the second half. The biggest problem now is that business spending and international demand have been weak and will continue to be weak for some time. Retail spending is not only slowing, but price erosion, price competition, price recession are growing across many parts of the retail sector. That's pressuring profit margins for many companies.

McIntosh: I'm a bit more optimistic. I think we could actually see a 3 to 3.5 percent GDP growth over the next 12 months. I think we're going to surprise on the top side. However, I think it's going to take some time. I think the first six months or so of 2003 will remain sluggish, but after that, the economy picks up. A survey just came across my desk of 700 chief financial officers of midsize businesses. This survey has been remarkably accurate over the past six or seven years. For 2003 it shows 70 percent are optimistic about the economy. They're actually going to spend more money than they did in 2002. This is the highest reading in the survey in the last seven years.

Blackburn: A number of analysts say that we're a little bit tired of saying that the recovery is just two quarters away. We've been doing that for two years now, but it looks like it's finally really coming. The first half of the year is probably going to be a little bit rocky as the uncertainty with Iraq and the war effort continues, and then we expect it to increase the last half of the year. We're looking for some improvement in the stock market by year-end, hoping that the Dow will be close to 10,500.

Huntley: Speaking of the Dow, is it safe to go back in the water again? Do you think we've put the bear market behind us, or is it likely to rear its ugly head again?

McIntosh: I think the Dow is going to finish out in the range of about 12,000 for the year, actually much above the consensus. And I think a lot of it is due to the economy. I think we're going to have a nice recovery. Also, the bear market is the longest since the Depression, longer than '73-74. Bear markets generally get long in the tooth, so to speak. They generally burn themselves out slowly. I think the surprise will be on the upside for next year. Right now, short positions obviously are extremely high, which sets us up for a powerful rally if we do take off as we did in August when short sellers got caught. Individual investors have pulled $35-billion in cash out of stock funds in the last three months. Where has it gone? Generally either into cash or bonds. Unfortunately, generally small investors are wrong at the major turns in the market.

Blackburn: I find it interesting that so many analysts are jumping back to the tulip mania of the 1630s, comparing our market excesses to that situation where in Holland the price of tulips just rose and rose. But it's very interesting that after two or three years of bear markets, there often have been great increases. So there is a good chance that we could have a big jump next year. I think it'll happen mostly in the last half of the year.

Henwood: I hope Tim is correct but, unfortunately, I don't think so. The direction of equities is going to be erratically upward. We think we're in a swinging equity market, a prolonged trading market, but I think that the conditions will get steadily better over the course of, hopefully, the next year. The problem is that the consumer is straining with more credit card debt. Corporate earnings benefited very much in 2002 from cost reduction and productivity gains. And now the other side is hitting them, which is weaker-than-expected demand and weaker-than-expected pricing. So you've got the whole deflationary concern.

We are clearly in the very late stages of this very prolonged bad market environment, and so the next question is how dramatic is the recovery starting in 2003, assuming we do have the start of a market recovery. I would expect the year-to-year gain would be more in the 10 to 15 percent range. If the consumer really retrenches, goes into a savings mode, paying-the-debts-off mode and stops spending, then we could have another ugly element to the market.

Huntley: What are your most promising investment ideas for the new year?

Blackburn: One stock that we're looking at closely is Qualcomm, which is a onetime high flyer. Qualcomm has the proprietary rights and will receive royalties from its Code Division Multiple Access (CDMA) technology. Eighty percent of the world is now using another technology, but in the long-term is expected to transition to some form of Qualcomm's technology. Part of Qualcomm's downfall was due to China reneging on a contract using Qualcomm technology. Now near-term growth is expected in China and India and in more developed markets. The expected annuity payments for royalties should stabilize income in addition to the growth prospects.

Another is Sysco Corp., the food distributor. It was expected that they would fall back with the economy because people would be eating at home, but that hasn't happened after all. With the recession they've cut back their operating expenses tremendously. They're poised for great improvement if the economy improves.

And then our last pick is Pfizer, a pharmaceutical company. They've got the strongest pipeline for R&D, for new products, from their research and development, and their price has really faltered, so it's an excellent value at this point in time.

McIntosh: We generally concentrate on four global sectors of the economy: financial, health care, technology and energy stocks. I have one pick from each sector.

The first selection is Schlumberger, the large oil service company. Their stock price basically has been cut in half for the preceding three years. They are a premier oil service company in the industry that maintains the highest operating margin and return on equity.

The next selection is Takeda Chemical, the largest Japanese pharmaceutical company. It's an ADR (an American depositary receipt held by a U.S. bank representing shares of foreign stock). It's one of the few companies in the Japan Nikkei Index that is actually higher priced today than back in 1990 when you had the start of the dramatic fall in the Japanese equities. They've got terrific new drugs coming into the pipeline and reasonable valuation.

SAP is one of our favorite companies. They're a large software company based out of Walldorf, Germany. They dominate the European market. They just rolled out a platform called, which basically integrates all the different major software programs, like accounting, HR, supply chain. We think there's a large, dramatic opportunity for growth.

The last one is a value in the financial sector, Wachovia. We think of Wachovia as the former First Union, which had a lot of internal problems. First Union did a lot of mergers over the past 10 years, and they were awful. But the Wachovia management team is really a tremendous team. They're the fourth largest bank in the U.S. The price-earnings ratio is only 11, with a growth rate, we think, of 10 to 11 percent, and there's a dividend yield of 3 percent as well.

Henwood: The first one is CBRL, which is Cracker Barrel restaurants and Logan steakhouses. Excellent management. Improving operating margins. Pricing power. High confidence in our earnings estimate. We look for 20 percent growth next year and the year after. Attractive valuation; the stock is currently selling at 13.8 times our 2003 estimate.

The next stock is one that would have formerly been a growth company but has now become a value company, Home Depot. We think, first of all, the initiative its management has taken to improve selling at the store level, improve inventory turnover and improve the information management system is going to help the company dramatically in the next two years. Also, it's a company with high returns on invested capital, about 18 percent, improving profit margins, and the company is selling at a 10-year low PE. Right now, it's selling at 13.6 times our 2003 estimate. This is an 18 percent grower.

Our third one is a pure growth recommendation in a very troubled industry, Jet Blue. This is a low-fare, low-cost airline with premium service in an all-coach business model. They're profitable. They're growing rapidly, They're efficient. They take market share in any market that they go after. They're going to expand their aircraft fleet at least by 75 percent in the next two years. We're looking for $1.23 this year, $1.80 next year and $2.35 in 2004. This is probably the strongest earnings growth story we have without major leaps of faith through the presumptions of demand.

I have disclosures that I have to make as part of the new mandate for brokerage firms. (See note below.)

Huntley: We've had some scandals in accounting this year and WorldCom, Global Crossing, Tyco and Enron. Has this changed the way that you go about your work? Do you do anything differently to try to determine whether the financial statements are, in fact, reliable?

McIntosh: The biggest disappointment for me was the outright fraud, and that's something that, as an analyst, you don't know. You have to take them as honest. So the benefit of all this is, hopefully, it's past us.

Huntley: You haven't really changed what you're doing?

McIntosh: One effect of this, to me, is that I will listen a lot less to what management has to say. I think I now focus more on the actual balance sheet, financial statement, more on the numbers than on what was said.

Henwood: Tim is correct. An analyst can determine whether accounting tends to be more aggressive or more conservative. They can look at how the various things are treated, how they treat research and development, how they realize revenues, how they manage costs and expenses. They can try to relate earnings to cash flow, and they can make judgments about companies. The bigger challenge is to make judgments about the management. There are a lot of very smart, impressive, lucid, energetic executives who are dishonest. Therein lies the new reality of the new market. You have to really get a feel for whom you want to get into bed with.

Blackburn: One thing we certainly look for is to make sure that the companies we're investing in have signed the SEC-required documentation for their financial statements.

Huntley: As money managers, do you trust the recommendations that you get from brokerage firm analysts? Do you think they're any more trustworthy now than they were before?

Blackburn: I think there's an increased level of scrutiny and review, and I think they know they're going to be watched. You don't depend on just one company's research materials. That way you get a flavor for what several different people, several different firms have decided.

McIntosh: I try not to rely on Wall Street as much. Maybe we look a little closer, but just like in any profession, there are certain analysts that are going to do a fantastic job no matter what, and then others are going to be swayed, so I think it's our job to try to identify the best of breed.

Henwood: This whole process of predicting the future is very challenging, and you've got to have independent thinking. You've got to use your own judgment. You can't wait for Wall Street to all come together and make the decision to downgrade. From an integrity standpoint, I think the process has been enhanced, and hopefully the major firms that are going to pay fines of some $1-billion will do more than give lip service to this.

Huntley: We hear a lot about the lack of investor confidence. Do you think that this lack of trust is going to be a serious drag on the markets next year? And what is it going to take to bring investors back into the markets?

Henwood: Clearly, the major things that will push them back into the markets are (1) the fact that they can't get any returns from debt securities, and (2) the resolve not to be in equities or not to buy them gets blown away by a resurgence. If Tim is right, they'll come back sooner than I expect. If I'm right that it's kind of a slow process, then they're going to come back slower. There are individual investors that feel today there's no way they will ever buy a stock again. There will be some that won't do that, but others will when they see some of these stock price movements in a better environment.

Blackburn: I think demographics are going to play a big part. I think the younger investors who have more time ahead of them will come in sooner than older investors because the older investors have seen their wealth shrink, and if they're not working, they can't replace it. So I think those people will be later getting back into the market and probably never as much as they were. The credit situation also is a problem because people have taken advantage of the zero interest rates and the low interest rates and increased their debt. Some instead of putting money back into the market will have to take it out.

McIntosh: A fact I've found interesting is after the '73-74 bear market, people continued to pull money out of equities for five or six years. I wouldn't be surprised if that were the case this time as well. The individual investor stayed away, and the institutional investor kind of carried the day for the next several years. Annual returns after the bear market, from 1974 to 1980, were about 121/2 percent, so I think that's a realistic scenario going forward, but I don't necessarily think that the individual investor has to participate and fund this growth. Now, if the individual investor does come back, then I think that might spur even further growth in the equity market, but I think a lot of individual investors have been essentially burned in this bear market. Many of them came in the late 1990s with expectations of returns of 30 to 40 percent. I don't think they're going to be ready to get back in unless they feel that the expectations are back there again to those levels.

Blackburn: It gets back to the psychology of investing. Perhaps for less savvy investors, the reason they tend to pull that money out is they lost money. Once the stocks go back up to the price where they invested, they'll say, oh, I'm even and get out.

Huntley: What about your own clients? Have they all gone conservative? How has the dynamic of the manager-client relationship changed for you? What are you doing to reassure your clients?

Blackburn: We feel very lucky that we've had few phone calls from nervous clients. There was an elderly woman who wanted to go all cash right away when it started falling, and that's okay for her. Money is to make you happy, it's to make you feel good, and if you can't sleep at night because of your money, then you need to make a change. We keep pointing to the long-term trend in the marketplace to our clients and what's happened historically, so that gives them confidence to stay in the market, weather the storm.

McIntosh: Our clients have pretty much remained calm. One advantage of the market falling so dramatically in a bear market is expectations come back down from the clients, where the expectations aren't for a 30, 40, 50 percent a year.

Huntley: Do you think interest rates are likely to tick back up this year, and if they do, what do you think that going to do for stocks?

McIntosh: My biggest fear in the market for 2003 is that interest rates will rise dramatically. Overall, the interest rate picture over the next three to five years, I feel that will probably be in the 4 to 6 percent range. I think interest rates should stabilize over the next several years, but we do have a moderate probability of interest rates tightening up, inflation coming back in.

Henwood: Well, I don't think there's going to be any notable change in interest rates through let's say spring of 2003. I do think they will start up by sometime summer of 2003. I wouldn't be expecting a sharp upturn. Equities don't like rising rates, but if they're moderate rises, and you see economic growth, you see earnings starting to accelerate, and you can be more enthusiastic, more confident in management, accounting firms and the securities industry, you might be able to digest it.

Blackburn: I don't think interest rates are going to tighten up this year.

Huntley: Where does war fit into this whole picture? How are the markets likely to respond if we get into a war with Iraq?

Blackburn: I think it's pretty much factored in right now that we are going to war.

McIntosh: In 1990-91, once the Gulf War was started, the market rallied from that point, and I think it takes out a lot of uncertainty. The greatest problem right now is that there's an uncertainty with Iraq, waiting for something to happen.

Henwood: Clearly, how the war goes will have some influence. If it goes well, and I would expect it would, that would certainly be a positive. Certainly, if it doesn't go well, that would be a negative. If we have a prolonged war running a number of quarters, not a number of months, the deficits are going to go up. That's going to lead to more concerns about interest rates, to more concerns about how to value equity. So that's the major issue there. And clearly, it's not going to be any surprise if we go to war.

Huntley: There are a lot of investors out there who still are holding some technology shares. When do you think we'll see the technology sector recover?

Henwood: We haven't made tech recommendations for years. We turned negative on the Internet at the end of 1999; we turned negative on tech and basically eliminated them from our recommended list July-August of 2000, and we remained, on balance, cynical. I think the worst of tech is behind us. There's still some companies that aren't going to make it. There'll be more bankruptcies, telecom spending is the worst of all, so if you're going to buy tech I'd rather not start with telecom. I think you're going to have a protracted, relatively modest recovery in tech spending in 2003.

Blackburn: I think Dave is right in that technology stocks aren't going to be increasing as quickly. They're going to be taking a little bit longer.

McIntosh: I'm optimistic on technology going forward for this year. What I've noticed in the past two to three years is that the companies that dominate their industries ended up stronger within the past two or three years, the survivors, so to speak. Many of the weaker players in the industry have fallen by the wayside or gone under and have actually made the larger companies, the technology companies, better investments. The valuations now have finally come down, many of the premier technology companies like your SAPs, your Microsofts, are all trading at valuation levels in the mid 20s, which we feel is good value going forward.

Huntley: Thank you.

Note: Raymond James is a marketmaker in CRBL and JetBlue and participated in the JetBlue initial public offering in April 2002. The company has not done any investment banking for CBRL Group or Home Depot in the past 12 months. The analysts who cover these three stocks do not personally own any shares. Raymond James' money management subsidiaries do not own 1 percent or more of the outstanding shares.

-- Times editorial assistant Barbara Moch helped prepare this transcript. Helen Huntley can be reached at or (727) 893-8230.

Stock picks

Here are stocks chosen as promising by the investment professionals who participated in the round table:

Gloria Blackburn, Premier Investment Management

* Qualcomm Inc. (QCOM)

* Pfizer Inc. (PFE)

* Sysco Corp. (SYY)

David Henwood, Raymond James & Associates

* CBRL Group Inc. (CBRL)

* Home Depot Inc. (HD)

* Jet Blue Airways Corp. (JBLU)

Timothy McIntosh, Strategic Investment Partners

* Schlumberger Ltd. (SLB)

* Takeda Chemical Industries Ltd. (TDCHF)


* Wachovia Corp. (WB)

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