Onward, Upward

Inoculate yourself against the stock-market bears. They will be everywhere once the year begins. They will be telling you that the easy money has been made, that it is a market of stocks, not a stock market, and that the average stock has already made its run. You will hear genuine Ursa Major growling about repetitive Fed rate hikes to slow down inflation. You can expect that the “rigorous” grizzlies, the always bearish intelligentsia, will put fangs and claws to everything from the dollar to tech to bonds. They will tell you to sell everything that’s not nailed down; they will tell you to sell short things you don’t even own!

And they will be wrong. As they were wrong in 2003. Because, despite the huge run we have had in the stock market this past year, we have more room to go, maybe even much more, as the country’s economy shakes off three years of contraction and begins to grow again. I know it seems Pollyannaish, if not downright unrealistic, but for the life of me, I can’t be bearish on stocks during the first full year of an economic upswing when a pro-investor president looks like he might win in a landslide.

Conventional Wall Street wisdom going into 2004 has it that we could be on the verge of a year like 1994 or 2000, the last two times the Fed had to tighten aggressively to cool off the economy. Heaven knows it would make sense for the Fed to tighten. Even though inflation remains low, we have a barn burner of an economy, with soaring industrial production and colossal gains in gross domestic product. While we haven’t created any jobs to speak of yet, history tells us that one year after interest rates bottom—March 2004, in this case—we see large jumps in payrolls. Whenever we see those jumps, give or take a month, the Fed always tightens, even when it says it won’t.

I want to take the 2000 Fed comparison off the table. The Fed superheated the economy four years ago, virtually flooding it with money, to ameliorate any Y2K glitches. That, plus the dot-com bubble, made Fed vigilance a necessity. We have no such bubble in the stock market now. We’re still way below historical equity highs even though the economy looks much stronger now than it did before we reached those highs last time.

The better example—and to some graybeards, a more worrisome one—is 1994, when the Fed put in six head-slamming rate hikes in a row. The averages marked time because of the rate boosts. But the averages lied. The flat Dow masked mammoth moves to the upside for the smokestackers, the big industrial and technology companies that thrive on a strong economy, and absolutely scary declines in the financials and the home builders. I think 1994, not 2000 and its bearish aftermath, is the more relevant parallel. I’m placing my bets for 2004 strictly using 1994’s tip sheet.

Most people can’t recall the 1994 tightening cycle. Not me. I lived through it as a hedge-fund manager. Right about the moment when my wife was giving birth to our second child, right at the moment when I was supposed to be saying “push” or “there she is,” I took a phone call from my partner at my hedge fund telling me that the Fed had just tightened 50 basis points and that it might be done tightening. As my mortified wife looked on, I barked out orders to cover the Dow, cover Alcoa, lest we lose a fortune and our shorts.

And while I may have created years’ worth of future psychological damage for generations of Cramers with that phone call, I nailed the tape right. The cyclical stocks, precisely the ones the Fed was tightening to stop, just kept on rolling, because almost invariably when the Fed starts tightening it makes you feel that it is almost done tightening, and nothing ignites a market like the “last tightening” in a cycle. I believe the same thing will happen again. The winners will be the Phelps Dodges, the Dow Chemicals, the Alcoas, and the technology stocks that do best when boom times are upon us. Typically that means Intel, but this time I think it could extend to Micron, the commodity memory-chip maker that could explode upward, as it has other times when the economy worldwide has kicked into high gear. Cheap stock, Micron. Hated and cheap at $11.

Don’t overlook the oils either. This group does incredibly well when the Fed starts tightening. ExxonMobil, ChevronTexaco, and ConocoPhillips could be big winners in 2004. I just picked up some ChevronTexaco, betting that this multi-year wallflower finally gets called to the dance floor, and I always hate the oils.

But the 1994 history also shows some big losers, notably retail and the banks. These two groups, winners at the start of 2003, limped into 2004, as big mutual-fund managers recognized that these stocks almost always underperform during the initial tightenings. For some of these stocks, the bears’ warnings will be right. They will look cheap on paper, but they could fold if rate hikes send emotional jitters through consumers who have been living off easy credit for several years now. I no longer own Target, I sold the Kohl’s, and I can’t even fathom Wal-Mart here. The drugs and foods should do nothing initially. It takes four or five tightenings before the economy is sufficiently cool enough that an Anheuser-Busch or a General Mills makes sense. But midyear, if the Fed’s too vigilant, you will have to scale back out of the smokestacks and into the stocks found in the medicine chest and the fridge.

Why aren’t I more worried after the outsize gains of 2003? Why can’t I join the chorus of those talking heads who say “It can’t be as good as it was” or “Valuations are already stretched like rubber bands about to break”? Two reasons: One, those same pundits probably missed the whole rally in 2003, and two, if you read these columns this year, you know I didn’t.

How good will it be? Good enough to make me wish that I could un-retire and go back into that trading turret I left at the end of 2000.

Yeah, that good.

Onward, Upward