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Wednesday, October 22, 2008

Who will the leaders be when the next bull market begins?

Merrill Lynch just released their latest installment of the RIC Report, the periodic update from their Research Investment Committee led by well known investment strategist Richard Bernstein.

Among other things, the report makes the point that "extreme volatility always signals a change in leadership". We are certainly seeing extreme volatility these days with the VIX hitting records left and right.

To determine who the new leaders will be, it is necessary to identify who the former leaders were and why they attained leadership. The RIC Report specifies the following:
Our theme continues to be that every growth story of the past 5-10 years has been based on the credit bubble. Whether it is China, Emerging Market infrastructure, energy, commodities, residential real estate, hedge funds, or private equity funds, the similarity they all share is that they are extremely capital or credit intensive and had easy access to cheap capital.

The days of easy access to cheap capital are over. The market’s new leaders will be the assets that are best suited for the new economic realities.
The current set of faltering leaders, in Merrill's estimation, are the most capital intensive sectors: Small Caps, Energy, Commodities, Emerging Markets, Housing, Real Estate and Low Quality Bonds.

Who are the new leaders?

Merrill expects the new leaders to be derived from the following: higher quality assets, developed markets, US Large Cap stocks and non-US Small Cap stocks.

In defining higher quality assets, Merrill is looking for cash-flow stable companies, especially those companies that offer dividends. Among the sectors Merrill likes are Consumer Staples and Health. Among developed markets, they like the U.S. and Japan.

The Merrill approach seems to be pretty conservative and rather defensive. What if an investor is looking to take on a little more risk?

It seems clear that the days are over when financial engineering could drive the economy. With deflation of the credit bubble, increased scrutiny from regulatory bodies and the government even owning stakes in many financial companies, I suspect we will see much less of the shenanigans that got us where we are today. As those companies that benefited from the old environment begin to take a diminished role in the economy, there could be a resurgence in the prominence of companies that make "stuff".

This means we could see the old fashioned Industrial sector begin to make a comeback. This, in turn, implies that worker productivity will again be a defining factor. How do most companies increase productivity? Usually through better use of technology.

So it is my opinion that the Tech sector could turn out to be one of the leaders in the next bull market. In a nod to Merrill's analysis, I can see the large-cap tech stocks being especially strong in this situation. These are the bellwether stocks with major market share, billions of dollars in cash and international operations like Cisco Systems, IBM, HP, EMC and Intel.

Conclusion --

Though we seem to be in the most depressing stage of a severe bear market, it is not too early to be looking forward to what comes after. When the next bull market starts, and it surely will eventually, it is useful to have an investing strategy in place. I would submit that Tech, especially large-cap Tech, could be one of the strategies worth consideration.

Disclosure: none


Andrew Abraham said...

We have been chatting on if now is a time to get involved in the stock market...this is the first time we are at fair value... but can't cheap get cheaper..what do think

Andy Abraham

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