Economic Outlook 2002 Word on the Street: Be Careful

Index of L.A.-based securities, after declining for two successive years, may rise a bit in 2002, but substantial gains are unlikely.

By ANTHONY PALAZZO

Staff Reporter

After two forgettable years, will stock markets return in 2002 to their winning ways of prior years?

Perhaps, but few expect a reprise of the go-go days of the late 1990s, when the Standard & Poor’s 500 index routinely posted annual gains of 20 percent or more. With the economy still in the doldrums, many investors would be happy with a modest rise in stock prices next year.

“It’s not going to be a 1990s-style market where you throw a dart at a page and it goes up. It’s going to require more careful selection,” said Chris Orndorff, director of equity strategy at money management firm Payden & Rygel in downtown L.A.

Indeed, fallout from Enron Corp.’s collapse is expected to temper any resurgence in stock prices next year, as investors become more cautious about company-generated claims. Nevertheless, local professionals see plenty of opportunities among local companies and stocks in general.

“I think equity markets are very likely to be positive next year,” said Gary Lisenbee, president of Newport Beach-based Metropolitan West Capital Management LLC, specializing in value-oriented equities. “Over the next couple of years, we believe that equity returns are very likely to revert to more normal historical returns in the low teens, between 10 to 12 percent a year.”

Through Dec. 26, local stocks measured by the LABJ 200 Stock Index were on track to lose 10 percent of their value in 2001, compared with a loss of 13 percent in 2000. The LABJ 200, whose makeup reflects the area’s diverse base of small-to-medium sized companies, has outperformed the Nasdaq composite index (down 20.6 percent this year) and the broader S & P; 500 (down 13 percent), while trailing the Dow Jones Industrial Average of 30 major U.S. companies, which lost 6.5 percent. (Walt Disney Co. is the only LABJ 200 member that is in the DJIA.)

Lisenbee expects stocks to begin looking past the prospectively transitional 2002 to a healthy 2003, once companies begin to report increasing demand and firmer earnings forecasts. “All the market needs is some visibility that a rebound is on the horizon,” he said.

Computer software leading

Among local companies, some of last year’s biggest winners are on investors’ short list for continued gains next year. Computer software was the LABJ’s best-performing sector in 2001, with a rise of 110.1 percent through Dec. 26. The group was led by video-game software companies Activision Inc., up 166 percent, and THQ Inc., up 115 percent.

While the run-ups have made these stocks expensive, some believe they still have legs.

“There’s a lot of upside for all these guys, and we think it’s a 25 percent growth industry for the next five years,” said Michael Pachter, head of research for Wedbush Morgan Securities. The video-game industry, reveling in the introduction of new hardware this holiday season, is a $12 billion industry, and projected to grow to $20 billion next year, Pachter said. This growth, along with increasingly realistic effects, makes video games an important new market for Hollywood talent.

One local sector that’s done surprisingly well this year has been the Internet (up 19 percent year-to-date), where big gains from Overture Services Inc. (formerly Goto.com) have made up for flame-outs such as Digital Lava Inc., Styleclick Inc., Homestore.com Inc. and L90 Inc.

Overture, L.A.’s top-gaining stock in 2001, has seen its shares nearly quintuple this year. Overture has positioned itself as a middleman providing new revenue streams for Internet advertisers with well-targeted placement and search engines. Overture’s stock, which started the year at $7.31 a share, was trading at $35.32 as of Dec. 26.

Providing a stark flip side to Overture is Homestore.com, whose stock has imploded this year, falling from $20.13 at the end of last year to $3.60 before trading was halted Dec. 21 amid a Securities and Exchange Commission accounting inquiry. Homestore, the heavily-hyped real-estate portal that drew antitrust scrutiny for its purported dominance of online real-estate listings, could become L.A.’s poster child for post-Enron accounting do’s and don’t’s.

The message: Internet stocks can be a bargain, but look before you leap. “I buy Internet stocks as long as I can find companies with decent balance sheets,” said Ed Wedbush, president of Wedbush Morgan. “If I find companies appearing to behave responsibly from a financial point of view, I look at them very carefully, because (valuations) make those companies interesting.”

Telecom woes

Another area investors are steering clear of is telecom. Sector-wide, it’s down 50 percent year-to-date, and that includes 214 percent gainer OSI Systems, the security systems company that surged after Sept. 11. In a shaky economy, telecom firms are expected to see continued difficulties. “Companies that rely heavily on capital spending are going to have a difficult time,” Orndorff said.

Among the L.A. area’s biggest losers in 2001 were optical-networking oriented companies like Optical Communication Products Inc., MRV Communications Inc. and its sister-company spin-off, Luminent Inc., each losing between 60 percent and 70 percent of their value.

On the other hand, certain pockets of the L.A. economy continue to generate excitement. The continuing exodus of large companies from the region has been a boon to locally based financial institutions, Wedbush said.

Orndorff likes ethnic Asian banks such as Cathay Bancorp Inc. “They have a loyal client base, they generally give good service and have low loan losses, they’re well capitalized and they fill a market niche that is growing in affluence,” he said.

He’s also sweet on biotech companies such as Amgen Inc. and Acacia Research Corp., as large pharmaceutical firms increasingly turn to partnerships with smaller companies that can inexpensively carry out new-drug discovery.

Among Lisenbee’s favorites for the new year are Disney and Unocal Corp. “If you’re a contrarian, (Disney) is one that’s clearly been impacted by the slow economy, they’re being hit by less vacation travel,” he said. “It’s not a stock that we own, but it’s an interesting situation that one could look at as a long-term contrarian play that you could buy at a low price.” Unocal has been too vulnerable to low natural gas prices, but it’s refocusing on more stable areas of production, he said.

Even lowly Capstone Turbine Corp., the area’s biggest loser of any significance this year (it’s down to $4.17 recently, from near $100 a share a year-and-a-half ago), has its fans, including Wedbush. He considers the stock a “pretty decent speculation for 2002” notwithstanding the “hold” recommendation issued by his own firm.

Capstone controller Wade Welch said he expects rising electricity rates to make his company’s microturbines more attractive to customers in California.

“The crisis as defined by blackouts and brownouts may be behind us, but that’s translated into a crisis in the economics of electricity.”