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INVESTING: Look to battered sectors for bargain investments

December 31, 2007

This was a puzzling year for investors. It began with ample lowcost money available to borrowers and record-low volatility across markets. It will end with a credit crunch hobbling financial firms and a market punctuated by volatile spurts.

And yet despite this significant shift in market character, the major averages will end the year with modest positive gains.

The year began with a sort of benign complacency for investors, as stocks had been on a smooth upward trajectory since the summer of 2006 and there seemed little reason to expect anything different. The stock market shrugged off its first bout with subprime mortgages in late February and went on to record-strong returns during the spring.

Then in mid-July came the unwelcome news that two multibillion-dollar hedge funds managed by Bear Stearns were deemed worthless. The funds had to declare bankruptcy when the prices on subprime mortgage securities plunged and the market became illiquid. Since then, stocks have tried to rally through the bad news of losses by the large banks in their mortgage portfolios.

This also was the year for "alternative investing" as private-equity funds and hedge funds attracted huge sums of investor money. A few of the larger alternative funds took advantage of this popularity by launching IPOs. The buyers of those initial public offerings have since suffered losses, once again proving that investors should be skeptical of buying into an over-hyped industry where the principals are selling.

As the credit markets froze, large privateequity firms deals slowed dramatically. And hedge funds, on average, are turning in another mediocre year, although the fees they rake in are still keeping gardeners in the Hamptons busy. To repeat a prediction we have made before, the returns on alternative investments will disappoint investors going forward.

The U.S. dollar headed south throughout 2007. As such, foreign corporations and sovereign wealth funds in places like China and Dubai are actively purchasing U.S. assets at bargain prices. Nothing seems to disturb the powerful global economic machine led by China's double-digit economic growth. The other big beneficiaries are commodity-based economies like Canada, Australia and Brazil, which export their resources to the fast-growing Asian economies.

In the United States, we approach 2008 with a slowing economy. A key issue is whether the credit crunch-and other problems affecting the financial and housing markets-will spill over into the broader economy. Or, will continuing powerful global growth trump our domestic economic problems? Sectors of the U.S. economy that serve the global economy-such as materials, certain industrial and manufacturing companies, and the energy sectors-have been strong, and stock prices are high.

On the other hand, the consumer discretionary sector-which includes retailers and anything housing related-has been clobbered along with the financial sector. Investors looking for bargains may look here for their next investment idea.



Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.
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