Hot or Not?
This week we rate discount retailers, big banks, pharmaceuticals and cyclicals.
March 7, 2002: 4:51 p.m. ET
By Staff Writer Paul R. La Monica
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NEW YORK (CNN/Money) - There's more to the market than technology, people.
In the first two installments of our new "Hot or Not?" series, we looked exclusively at leading tech stocks, including Microsoft, Intel and Cisco Systems.
But with the overall market experiencing its own version of March Madness thanks to strong economic data, it's time to look at some other types of stocks as well. As momentum has picked up, some stocks and sectors are getting swept up in this latest wave of enthusiasm for no good reason. So with that in mind we're putting four sectors under our Hot or Not microscope.
Discount retailers Recession? What recession? It's hard to find a hotter group of companies than the bargain retail chains. Same-store sales for Target were up 8.5 percent in February and Wal-Mart's increased 10.2 percent. Discount department store chains have been doing extremely well also. J.C. Penney's same-store sales jumped 12.5 percent and Kohl's surged 14.4 percent last month.
The stocks of Wal-Mart, Target and Kohl's are all within 10 percent of their 52-week highs. These three chains have already begun to benefit from Kmart's bankruptcy and it is likely that they will continue to gain market share once Kmart begins to close stores. Kmart is set to announce on March 11 how many stores it will be shutting down.
Discount retailers have held up extremely well during the economic downturn as consumers flocked to stores offering bargains. But there's no reason to think that the discount chains will take a hit once the economy improves. Consensus earnings estimates for fiscal 2003 (ending in January) for the three companies have all been revised upward in the past month.
Wal-Mart's earnings are expected to increase 18 percent this year and Kohl's earnings are estimated to be 21 percent higher than last year's. Target is on track for a 13 percent jump in earnings.
Big banks and brokers It's been a tough couple of months for Wall Street and things don't seem to be getting better for the industry. Reports circulated last week that Credit Suisse First Boston and Goldman Sachs would soon lay off more workers and that sparked a new round of job cut fears throughout the industry.
Investment bankers haven't been as busy as they have in years past. According to data from Thomson Financial, the dollar value of mergers announced so far in 2002 is down 57 percent from the same period last year.
Debt and equity underwriting isn't taking up the slack for lower merger advisory fees either. So far this year, dollar volume for new debt and stock offerings are 8 percent lower than last year. As a result, it should come as no surprise that the consensus 2002 earnings estimates for Goldman Sachs, Merrill Lynch, Morgan Stanley Dean Witter, Citigroup, JP Morgan Chase, and Lehman Brothers have all been lowered within the last month. On average, the six stocks are 23 percent off their 52-week highs. Notice a trend?
If this wasn't bad enough, the investment banks are likely to have their names dragged through the mud by politicians. Congress sent letters to 10 investment banks on Wednesday asking them to detail their relationships with Enron. It's an election year and it doesn't seem like Congress is going to let go of this scandal anytime soon. Something tells us that investment banks aren't going to emerge from congressional hearings in a favorable light.
Drug companies Huey Lewis, one of the great singer-songwriters of the 1980s (yes, that's sarcasm, folks), once crooned "I want a new drug." He's not the only one. As a matter of fact, it's the predicament that most big pharmaceutical companies are facing.
The absence of new blockbuster drugs has led some drug companies to seek partners in the risky biotech industry. But that backfired in a big way for Bristol-Myers Squibb, which agreed to invest $2 billion in ImClone Systems in September and promptly watched ImClone's stock plummet in December after the Food and Drug Administration deemed the company's application for its Erbitux cancer drug incomplete.
In addition, many big pharmaceutical companies also have to worry about increased competition from generics, now that the patents of many top drugs are expiring. The patents for Eli Lilly's anti-depressant Prozac and AstraZeneca's ulcer drug Prilosec expired last year and the patent for Schering-Plough's allergy medication Claritin is set to expire this December.
There's also the fact that drug companies, simply put, are defensive stocks in nature. That means they will probably underperform in a strong economy. To that end, when the Dow, S&P 500 and Nasdaq all posted big gains in 1999, the Amex Pharmaceutical Index actually fell 10 percent.
Boring cyclicals It's true that paper and chemical stocks do little to quicken the pulse. But there's absolutely nothing boring about making money. And as long as the economy continues to show signs of a recovery, it's likely that cyclicals will do really well. Strong data from the manufacturing sector recently is particularly encouraging for these stocks since a turnaround in manufacturing should lead to greater demand for steel, aluminum and plastics.
Investors are certainly betting that the economy will continue to gain momentum. Natural resources funds, which tend to invest mainly in cyclicals, are up an average of 7.4 percent so far in 2002. The only domestic fund category that is doing better is precious metals, with a glittering 22.9 percent year-to-date return.
International Paper has been one of the hottest stocks in the Dow Jones Industrial Average in recent months, soaring 43 percent since the market's Sept. 21 low. It's also up nearly 10 percent this year. Analysts are predicting a 123 percent jump in earnings this year following an earnings decline in 2001. DuPont and Dow Chemical are also expected to post strong earnings gains this year thanks to easy comparisons.
And even though the steel industry certainly has been struggling, there is some hope for the handful of companies that will survive. President Bush's plan to impose new tariffs on imported steel should benefit companies like U.S. Steel and Nucor.
Do you agree with our take on these four sectors? E-mail paul.lamonica@turner.com. Also feel free to let us know about other stocks, sectors, funds or even people that you'd like to see rated hot or not. 
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