A Buyer's Market

By Daniel Kadlec

Cold-eyed investors have made good money betting against the U.S. economy over the past year. Amid persistent weakness, bonds have soared while the dollar and stocks have plunged. But nothing lasts forever. Bullish investors learned that lesson three years ago when, with both eyes on the rearview mirror, they slammed into the back of a braking economy.

Now that business shows signs of picking up, many investors are set up for another accident.

If you must look behind, look at corporate profits, which were better than expected last quarter, and at consumer confidence, which roared back in April. Fed Chairman Alan Greenspan told Congress that with the war won, "the economy is positioned to expand at a noticeably better pace." How to take advantage? Buy cyclical stocks, lighten up on bonds, and buy shares of foreign firms that do lots of business in the U.S. or are in high-growth countries in Asia outside Japan. You may be early; move slowly over the next few months. You won't risk too much too quickly but will be in the right places when growth picks up.

Barton Biggs, chief global strategist at Morgan Stanley, says he sees too much gloom and doom even among professional investors. He expects consumer cyclical stocks to do well in the U.S. and Asia. Among stocks that Morgan Stanley has lately favored are U.S. consumer cyclicals Best Buy and Home Depot. The firm also likes techs, including Microsoft and Applied Materials, and industrials--Lockheed Martin, CSX--as a play on U.S. growth.

The dollar is a crucial consideration. As it fell 20% in the past 12 months, U.S. investors benefited in two ways: returns in foreign currencies got a boost when converted into cheaper dollars, as did profits of U.S. firms with operations overseas. On average, currency gains added the equivalent of 8.5% of net income to U.S. companies' balance sheets in the first quarter, reports Credit Suisse First Boston. Oracle enjoyed an $81 million currency gain--equal to 14% of net income that period. Yet its shares have languished amid a brisk tech rally, partly out of recognition that the equation probably will reverse.

So in the U.S. look for industrial cyclicals with relatively little foreign exposure, like Alcoa (12% foreign earnings) and Weyerhauser (16%). In Europe focus on multinational consumer-goods firms--Glaxo, Heineken, Novartis, Unilever--because they get a lot of revenue from their U.S. operations and would not suffer much from a currency reversal, says Ian Harnett, chief European-market strategist for UBS Warburg. Firms that rely heavily on sales in Europe will remain weak with the Continental economy. "European companies have not managed to restructure and shed costs as rapidly as those in the U.S.," Harnett notes.

A stalled Europe would help the U.S. deal with one of its main problems: a swelling trade deficit. Foreign capital goes where the growth is, and the U.S. needs such investment to whittle away the deficit, support the dollar and keep growth accelerating. David Bowers, chief global strategist at Merrill Lynch, isn't yet favoring U.S. cyclicals. "But we're watching very closely," he says, "and think the U.S. financial stocks, which have done well, may be giving us a signal" that growth is soon to return.

Asian economies would follow, though Bowers says he would avoid Japan. Among his favorites: Hong Kong, South Korea and China--despite the outbreak of severe acute respiratory syndrome. Consider cyclical blue chips like China Telecom, Hyundai Motor, Samsung and Taiwan Semiconductor. These moves may not feel right with the economy slow and the dollar weak. For now, just think of them as accident insurance.