January 2007

I'll probably make several 'looking forward' posts before the market opens back up on Jan 3. I tend to try and think 3 different ways. What's going to happen in the next month, next quarter, and next year.

For January 07, it's one of the first times in a while that I'm really torn as to what I think will happen. The bull and the bear camps make pretty compelling cases. Bulls think that the end of the year stall is just a stepping stone on a way to new highs. They cite the general lack of inflation, the overall strength of the economy, and relatively modest valuations (in terms of P/E multiples) against the historic averages.

Bears think we'll see a big selloff to start the year as people look to lock in their 06 gains after they no longer have to pay taxes this year on them. They also point to the poor housing market (bulls see a bottom forming, bears think it's going to get much worse), and a theory of 'stagflation' in 2007 where we have stagnant growth and heavy inflation.

So what do I think? Well, overall I'm not very sure. I think we'll see some quick policy changes in Washington as the democratic congress officially takes over. The most notable one being a minimum wage increase, which I believe will put pressure on low-margin retailers such as Wal-Mart and Target. I also believe that when the numbers come in that the holiday season will show record sales but lower than expected profits. I personally saw a lot of sales, and big ticket items this year like big screen televisions were heavily discounted with low margins (anyone who doubts this go look at that Circuit City quarter). I think both discount retail and big box retail will be bad places to be, but there could be some profits to be made in niche and high end retail. Half a stock's movement has to do with its sector though, and it's tough to fight that trend. I definitely won't be looking to add to any retail positions in early 07. I liquidated pretty much all of them towards the end of 06, although I do still hold a position in Sears (SHLD) and Lowe's (LOW). Sears is a long term play for me though and Lowe's always seems tied more to housing than retail.

Speaking of housing, I'm more in the camp that housing is starting to form a bottom now and it won't get much worse before it gets better. I'm actually putting my money where my mouth is because I'm planning on building a house in early 07 since I believe prices won't go much lower. That being said, I don't plan on buying any housing stocks directly, although I may look at stocks tied to housing. Lowe's is a good example, as well as things like American Standard and Black & Decker (neither of which I'm recommending, they're just good examples).

I also believe that some of the large cap technology stocks will do well in early 07. On a yearly cycle, usually January is the time to leave tech, and normally I despise fighting cycles too much (saying 'this time is different' is often a recipe for disaster), we do have a major new product cycle in Microsoft Vista that could drive a push in some of the larger technology names, especially those tied to networking and PC Hardware. The at home PC business has become such low margin I wouldn't recommend making a play on that, but looking at what companies may benefit the most as businesses upgrade to Vista may be a great play for 2007.

I think the drugs/pharma sector will be an interesting one to watch. I think January will be a good tell on if these stocks will be good for 07. The main downward pressure on them right now is that no one knows what the new democratic congress will do. They've typically been anti-pharma (and anti-oil) and there have been some talks that they may try and leverage Medicare Part D into favorable pricing from the drug companies, something that the old congress didn't do and allowed the drug companies to make a killing. I personally think that aside from the minimum wage raise and some general stick waving, we won't see much action and that the drug/pharma stocks will enjoy a good 07, but I'm not confident enough in that to put any money there until after I see how January plays out. If it goes as I plan, I think some of the small/mid-cap drug stocks will be the place to be. Not necessarily the 'miracle cure for cancer' type stocks, but mainly the smaller drug companies with strong pipelines and drug patents on strong products that don't expire for a while.

My reasoning is this. Some of the bigger names right now (I'm talking about you Pfizer (PFE) and Bristol-Myers Squibb (BMY)) have patents that expire fairly soon on key drugs and virtually no replacements in the pipeline. They do have a ton of cash though so I think they'll look to build their pipeline by acquiring others. I personally don't like to try and game takeover bids, but I think by finding some high-quality small/mid-cap drug stocks with solid fundamentals, you could do well with or without a takeover this year.

Energy is a tough call for me. Oil is stabilizing some IMO, and I don't think it's a bad place to be, but as the 2008 election campaigns start in force I think we'll see a lot of talk about alternative energy. I personally don't like alternative energy (the stocks that is), so I won't put any money there except for quick trades. I think a key to the whole energy sector will be how the weather works out. We've had a relatively mild winter so far, which has really hurt a lot of the stocks tied to natural gas. I don't like to game the weather, so I'll probably stay away, although I may look to add a high dividend oil stock to my portfolio in early 07.

There are lots of sectors I'm sure I'm not talking about, but those are the ones I have major opinions on. I personally think we could go either way in January. I've repositioned my portfolio in such a way so that a lot of my core holdings are high-dividend stocks or stocks with a big buyback. That puts a nice floor in the downside for me. I'll miss some upside if 07 comes out on fire, but I like my position overall. I also have a higher than usual cash position so that once I get a better feel for how things may play out in the first quarter I can put some of that money to work.

Overall I'm cautiously optimistic, and am mostly positioned that way. I'll really be keeping my eye on how the drug/pharma sector is doing and how the new congress starts out the year. The other sector I'm keeping a close eye on that I haven't talked much about are the banks/financials/brokers. They started to run some at the end of this year and I think there could be some money to be made there. Again though, I don't feel confident enough to put any money to work until I see how things start 07.

-Rizen