Ugliest ducklings become sexy in Wall Street surge

Alan Deans

New York View

Wall Street leaped through the 11,000 mark this week, capping a one-month surge that has seen the Dow Jones soar by more than 10 per cent. It is impressive that it is the fastest 1000-point rise ever, but what is more noteworthy is that the gains have come in stocks that most thought had been banished to a leper colony.

Cyclicals are back thanks to lower European interest rates, recovery in emerging markets and higher oil and copper prices. Investors have also begun to consider mid-cap and small-cap companies, a huge well of new opportunity that has been shunned for years as people poured money into a few high growth performers like Microsoft, Dell Computers, Intel and Cisco Systems.

The growth splurge is tapering off, however, as the technology darlings become so big that they can no longer find enough buyers to fuel 50 per cent plus annual revenue increases. Strange as it may seem, there are a finite number of PCs out there that need to be loaded with Windows 98.

While this provides a new challenge for Bill Gates, Michael Dell and others, it signals that Wall Street's bull-run might have strong enough legs to last for some time.

For about four years now, ever since earnings growth for the S&P 500 companies started to take a nosedive, the market has ridden higher on the bright outlook in the software and computer sector. Now the market is broadening out as investors rotate into companies with knockdown values.

It is still early days, but if commodity prices hold up and interest rates remain low then the new investment wave should be sustained. Such conditions will allow companies like Boeing, Alcoa, Caterpillar, International Paper, 3M and DuPont to post the higher profit numbers needed to justify the faith investors now have in their future.

The major risk, of course, is that inflation stirs again, causing interest rates to rise. 30-year Treasury bonds this week topped 5.7 per cent for the first time in nine months as people were spooked by higher than expected GDP growth and purchasing statistics by manufacturers. There are no concrete signs of higher inflation, but investors still want to hedge their positions.

Such jitters led to a quick retreat in the Dow below 11,000 points. It also knocked the NASDAQ market, where most technology stocks are traded because higher interest rates would threaten to slow growth rates even further.

But equity strategists now seem to think that the new cyclical favourites could hold up well into the northern summer, and that the rally could go much higher. One reason is that the Dow is a fusty old index, listing 30 stocks mostly founded in the 1800s. It is not a hi-tech measure by any means.

Another reason is that the Dow stocks have shrunk so much in outright valuation that their prices can be punted higher on comparatively light buying. They have been reacting to the spotlight more like tightly held Internet players than the blue chips that they are.

We seem to be at one of the major turning points when every equity investor needs to reassess their portfolio.
Some exposure to boring old basic companies that log trees, make paper, smelt copper, refine oil and brew chemicals now seems to make sense. It certainly provides a welcome new topic to toss over at dinner parties apart from the current boring favourite about how low Dell/America Online/Intel/etc can go.

* Alan Deans is the New York correspondent of The Australian Financial Review.