Industrial stocks tipped for success in 2005

NEW YORK - Pump cash into industrials, take a chance on drugs and be selective with technology -- that is the opinion of some money managers on Wall Street as they look ahead to 2005.

As the year draws to a close, investors are weighing up the unknown quantities for the next 12 months -- such as the dollar, oil prices and the strength of consumer spending -- as they ponder which sectors to favour.

Some of 2004's strongest performing sectors, such as energy and industrials are again tipped for growth, while some of the worst, such as pharmaceuticals, could rebound.

Energy-related companies posted the strongest performance in the S&P during the past year on the back of surging crude prices. Forecasting how crude fares in 2005 is key to predicting how energy stocks perform, analysts say.

Analysts at Oppenheimer & Co. Inc. think that, if oil prices remain around current levels, energy stocks could gain more than 10 per cent next year, but a drop in prices below $40 a barrel could depress the stocks and a price close to $30 could cause a sharp correction.

Owen Fitzpatrick, Head of the US Equity Group at Deutsche Bank Private Wealth Management, thinks oil prices will "remain strong enough to be a positive influence on the group".

But Tim Ghriskey, chief investment officer of Solaris Asset Management, is "cautious", on the assumption that energy prices will moderate.

Industrials were a strong performer over the last year, helped by robust economic growth and a number of analysts think the sector could continue to perform well as the economy remains on a steady path.

Standard & Poor's told clients in a research note the "continued improvement we see for the US economy" could help the sector.

Solaris' Ghriskey favours "economically sensitive sectors like industrials and basic materials," believing expectations for corporate earnings growth are modest for next year and that there is a potential for growth to come in higher than expected.

The retail sector is where some analysts have their doubts. Consumer spending, which makes up two-thirds of US economic activity, has fuelled growth, but some believe this could crimp next year as interest rates rise.

Morgan Stanley says in a note the consumer discretionary sector "lacks the pricing power we champion," while "we do not like the high valuations, tight consensus, and robust margins assumptions in (consumer) staples".

But Richard Bernstein, chief US strategist at Merrill Lynch, thinks one surprise next year is that consumer staples are one of the best performing sectors, saying it has "historically been the best performing sector when the profits cycle decelerated".

And Steve Neimeth, portfolio manager at AIG SunAmerica, says he is bullish on consumer cyclicals, believing employment and payroll numbers continue to improve, and on the bet that lower energy prices next year will act as a "huge tax break" for consumers.

Big pharma lost tens of billions of dollars in market value in 2004 as safety concerns about certain drugs, including Merck & Co. Inc. Vioxx arthritis pill and Pfizer Inc.'s similar offering Celebrex, caused stock prices to plummet.

But the declines have created opportunities, say some fund managers. Neimeth is bullish on health care and large-cap pharmaceuticals, arguing "we're seeing valuation we've never seen before."

Merrill Lynch's Bernstein takes a bold view, arguing in a note to clients that "pharmaceutical stocks have become the new tobacco stocks," with waning growth and litigation risks seeming common to both industries.

"We are certainly not suggesting that investors 'catch a falling knife,' but there might be a good buying opportunity in pharmaceuticals sometime in 2005," he added.

But on the cautious side is Ghriskey, who thinks health care is "full of land mines".

Tech stocks have underperformed over the past year after a rebound from the dot com and telecom busts of 2000 hit a plateau as cost-cutting by businesses and rocky economic currents cut into growth expectations.

Instead, industry consolidation, especially in the software and wireless sectors, have been key stock drivers, forcing investors to become more selective stock pickers for the rare secular growth stories or niche gadget plays.

Morgan Stanley does not favour technology and in particular semiconductors and hardware, arguing that valuations "remain high."

Deutsche's Fitzpatrick sees weakness continuing in the sector, on the basis that he is "not seeing any major pick-up in terms of demand there."

But Ghriskey at Solaris favors the sector, but cautions: "You can't buy tech blindly and you've got to be able to accept the volatility."

- REUTERS