Riding Global Growth

By Daniel Kadlec

Long-term interest rates were supposed to be going up by now, and after a blistering run, stocks may have got ahead of the recovery. Meanwhile, job growth has been lackluster, and suddenly terrorism concerns are back in the markets. In short, things are as confused as ever. To sort it out, TIME asked a panel of portfolio managers, moderated by senior writer DANIEL KADLEC, to assess the state of our investments. Our panelists are stalwart long-term bulls on the global economy and believe job growth will return this year. There is wisdom in dividends, they say. And the best buys in flat-screen TVs are the stocks of companies that make them. For more on that, and other pearls, read on.

TIME: Why don't we start with an overview. Where are we in the economic cycle?

RON MUHLENKAMP: We said in July '01 we thought it was going to be a normal cyclical recession, that we weren't headed for depression or inflation. We continue to believe that. Now we are at a transition point. The economy is stronger, and the markets have recovered the kinds of things you normally recover as you come out of recession, like technology and some speculative companies. So we think we are back to normal, but it is a normal we haven't seen since the 1960s. We think inflation stays at 1% to 2% and long-term interest rates stay under 5%. Short-term rates are lower than they should be. I'd be voting to raise them now. The only thing not back is jobs, which always lag.

TIME: But the lag is of record length and creating a political issue. What makes you sure we'll get a real jobs recovery?

MUHLENKAMP: I am an investor but also an employer. If I'm making money, there are two good reasons I hire: to make more money and to save time. Companies have been cautious, but the patterns are familiar. Jobs will be back.

ELIZABETH BRAMWELL: We have had 10 months of rising temporary employment, which is a good leader. And it's wrong to look at today's numbers without putting the year 2000 into context. That was the bubble. We hired anyone.

TIME: So we should never have had all those jobs to begin with?

BRAMWELL: Exactly. It's like looking at your stocks and comparing prices to when they were at their peak. That's unrealistic when the peak didn't last long.

ROBERT LYON: I don't think employment is as dire as the headlines. You couldn't have the strong retail sales we have if that were the case. People aren't getting counted because they are self-employed. You will see better employment growth the rest of the year.

TIME: From an investing view, is it important that jobs recover in the U.S.?

SUSAN BYRNE: Companies don't care if our children are working in a Nissan plant in North Carolina or if we hire an accountant in India. The kinds of jobs we create here and the kind we send overseas may have a profound effect on society, but it doesn't affect corporate profits. In a worldwide sense, we are having a strong and vigorous jobs recovery.

TIME: So it's about global job growth because it's a global economy?

BYRNE: That's the way we invest.

BRAMWELL: As a middle class develops in China and India, demand for American services such as life insurance, credit cards and mortgages will create enormous numbers of jobs here.

TIME: Liz, what's on your radar?

BRAMWELL: The big surprise is that interest rates, which are low, could go lower. On a bell-shaped curve from 1950 to 2010, the midpoint is 1980. Rates went up the first half of this period and are coming down the second half, with incredible symmetry. At 2010 on this curve, long rates are at 2%. Money will flow where the most attractive returns are likely.

TIME: And 2% is hardly attractive.

BRAMWELL: We think playing the developing middle classes around the world is smart. My grand concept is that when the Berlin Wall came down, it opened markets that companies never thought they'd get into. Developing a middle class in Asia may have even greater significance. Also, with T-bills yielding less than 1%, companies with solid dividends are an attractive alternative for many savers.

TIME: We've been writing about dividend payers for a year. They make a lot of sense but have lagged the market badly.

LYON: A shift started in November.

BRAMWELL: Last year was the year rates came down. It was the year for the really stressed-out companies to recover. Dividend stocks will do better now. Take a company like Procter & Gamble, yielding 1.8%. It increases its dividend every year. This is a large, seasoned company. You might be better off, in a diversified portfolio, having that rather than a money-market fund.

TIME: Rob, what do you see?

LYON: The stimulus put in place the past 18 months is huge and will spill into 2005. Profits are recovering, and that will lead to more spending and more employment. Inventories are really low. Our view is that getting inventories back up to a normal level would add as much as 1 percentage point to GDP growth. We think it's important to disaggregate between tech stocks and everything else. If you hadn't been through a tech bubble, you'd think you were in one now.

TIME: Are you avoiding even the big techs, like Microsoft and Intel?

LYON: We're underweight.

TIME: The few techs you do own?

LYON: The most interesting is Royal Philips Electronics. It has a major exposure to the semiconductor business and owns 50% of one of the largest LCD manufacturers. The flat-panel business is just exploding.

TIME: The Madrid bombing triggered the market's first 5% pullback in a year. Will investors ever get over these events?

MUHLENKAMP: Yes. We have learned that the economy won't shut down.

BYRNE: Shocks create value in certain areas. But to say they wouldn't create an incredible flight to quality is a mistake. This gets in the psyche of folks and causes them to be more cautious, along the lines of people's behavior in the 1930s.

LYON: It's just another reason that we are value investors. Every time you buy a junky little stock or a pristine one with a 40 [price-earnings ratio] and something goes bad, the trapdoor is infinitely larger.

TIME: Let's give Susan a chance.

BYRNE: After all we've gone through, why wouldn't you want a dividend? The check clears; you get the money. Everything else about the market is a judgment. Longer term, companies that pay dividends will be where you want to be. For dividends to go up a lot, you want to watch where the cash is. Congress is trying to pass a law that lets companies bring money back from overseas without paying tax on it. That would repatriate a lot of dollars available for dividends.

TIME: Rising rates would be awful for what has been a pillar of the economy: housing, which Ron loves.

MUHLENKAMP: We know some people who regret buying tech stocks. We don't know anybody who regrets putting money in their home. If mortgage rates got to 7%, it would make a dent. But rates now are at 5.5% or so, and long-term studies show that this is a normal mortgage rate. We don't expect housing starts to keep growing. But the publicly traded builders are taking market share from the neighborhood man with a hammer. That has become their edge, and these are companies that sell for nine times earnings.

TIME: What stocks do you like that take advantage of all the remodeling?

MUHLENKAMP: We own American Woodmark. It makes replacement kitchens sold through Home Depot and Lowe's. We own Whirlpool. It has washing machines priced three times what a standard washing machine is, and they are selling fast. There's a big difference in margins at the top end. This past recession Harley-Davidson sales didn't fall off, and Winnebago came through in great shape. We own both of those stocks.

TIME: You also like homebuilders.

MUHLENKAMP: Just about all of them: Centex, Meritage, NVR, Lennar. If I had to pick today, it would be Centex and Meritage. In the past 10 years, market share of the 10 largest builders has gone from 10% to 20%. I don't see anything to keep it from going to 40%, which means they have another decade to run.

TIME: Anything else?

MUHLENKAMP: Natural gas. We own Patterson-UTI Energy and Nabors, which own drilling rigs. We are using more gas than we are drilling. We know where to find gas. It's just a matter of drilling it.

TIME: Liz? Tell us what you like.

BRAMWELL: We like the natural-gas drillers too. We also think that as the global economy improves we want to be in global financial companies that have close relationships with clients. We own Citigroup and J.P. Morgan Chase. We also like Goldman, Sachs for investment banking and AIG in the insurance area. We think two growth areas are orthopedic-device companies and restaurants. We're going to end up with amazing things like artificial cartilage. In the meantime we are getting minimally invasive hip replacement. Companies in this area are Stryker and Zimmer. Casual dining includes companies like Applebee's and Cheesecake Factory, which benefit from families not sitting down together at home anymore but going out to do that.

TIME: Your turn, Rob.

LYON: We expect advertising to pick up and benefit Gannett and Clear Channel. They have very little capital spending and don't have to worry about Indian and Chinese competition. The second thing we like is everything geared to investment banking and brokerage. We are in the early stage of an up cycle, and business is taking off. We own Citigroup, Goldman, Sachs and Morgan Stanley. The other major theme we have is to own the companies that supply emerging markets, and that means both energy and agriculture. British Petroleum has a 4% yield. It has a big interest in a major oil company in Russia that is well positioned to supply China directly. The play in U.S. agriculture is in the early stage. The classic big-cap player is Deere. As a result of drought and stronger demand, carry-overs of corn and soybeans are at record lows and prices are up. Farm machinery is old. So we think Deere has an excellent shot at a multiyear run.

TIME: I don't hear anybody talking about defensive plays, just in case the global recovery falters.

BYRNE: We own Alcoa, which we consider a defensive play. Alcoa doesn't just make aluminum. It owns alumina, which is the starter, the yeast, and which is in short supply. Alcoa pretty much controls alumina in the world. That makes it special.

TIME: What else is special?

BYRNE: I also believe in the financials, names like Lehman Bros., which just reported earnings above expectations, and Bear Stearns, which is one of the best-managed companies on the planet. A number of the health-care companies are attractive. I don't know whether we will have a national purchasing system of drugs. From my viewpoint, it's irrelevant. Drug prices would come down with controls, but usage would soar. That's the nature of the business for Pfizer and Merck, both of which I find attractive. I want companies that no matter what happens, they would be able to pay me my dividend. For a defensive play in housing look at REITs [real estate investment trusts]. They are up three years in a row, and everybody thinks they're done, but I like Tejon Ranch, one of the largest landowners in California, and Rayonier, which owns 1.6 million acres of Florida timber. It's a real estate play with a 6% dividend for safety.

TIME: Which isn't a bad thing. Thanks, all.