oblivious to cautionary economic indicators. Closing at record levels more than 25 times since October, the market seemed to shrug at a potential housing bust, the looming prospects of inflation or recession, a huge deficit, and a plummeting dollar.
So it might be wise to take a step back, advises Randall Eley, president of The Edgar Lomax Co., an investment firm in Springfield, Virginia (No. 11 on the BE ASSET MANAGERS list with $1.6 billion in assets under management). He cautions that, though it may appear we’re in a “Goldilocks” economy–one that seems not too hot, not too cold, but just right–the markets don’t move inevitably upward. There are corrections along the way (for example, when an index drops by 10% to 15% but for no more than six months). Investors just might be due for one. “I don’t believe a conservative investor should expect those gains to continue,” says Eley, who is also the firm’s chief investment officer.
Particularly worrisome is the weak dollar, which sank 11.5% against the euro this past year. To firm up the currency, Eley says that the Federal Reserve Board may have to hold off for a while on cutting interest rates. That will deal a blow to already-slowing corporate profits, because a cut in interest rates would allow companies to finance possible expansion projects and other ventures more cheaply. As a result, this could hinder stock prices and tip us into a bear market. “It was a much larger drop than the Federal Reserve was expecting,” he says. “Now they’ll have to stabilize it to keep foreign lenders from moving away from the U.S. dollar–and that could force long-term [interest] rates up.”
But as a value-oriented investor, Eley says there are still a few bargains out there. Telecom names such as Verizon (VZ), with its fat dividend yield of 4.2%, look attractive. And financial giants
such as Citigroup (C) and JP Morgan Chase & Co. (JPM) have the “kind of price/earnings ratios we like,” says Eley, with P/E ratios of 12.3 and 12.7, respectively. He notes that this is in line with banks of this stature, which as a group currently carry a P/E ratio of 14. Meanwhile, Eley is shying away from utilities, which have soared so much in the past year or two that they’re no longer buys. Note that the Dow Jones Utilities Index climbed 36% from the start of 2005 through the end of last year.
Other market watchers, though, are more bullish about 2007’s prospects. Carla Harris, a managing director of global capital markets for Morgan Stanley, points out that there is a high likelihood that key economic indicators, such as interest rates, inflation, and oil prices, trade in a narrow range this year. “As long as those stay steady, we can expect another good year,” she says.
Mix in the fact that private equity firms, hedge funds, and corporations are all flush with cash, and it could be another year of solid gains. So initial public offerings are hot, share buybacks are