Big Deals, Big Firms Rule Picks

(Paul Sakuma -- The AP)

"One thing I got wrong last year is that I thought small caps, especially technology, were going to meaningfully underperform," Golub said. "Next year, I think large caps are finally going to do well."

Big companies with lots of cash on their balance sheet also tend to do better in an environment of rising interest rates because they are less dependent on borrowing. Multinational firms also have exposure to the surging euro and other currencies and are thus less susceptible to a falling dollar cutting into profits. And they tend to be bigger exporters able to capitalize on a weaker dollar, making their goods cheaper for foreigners to buy.

Among big firms, several analysts mentioned Citigroup as an attractive prospect. While beset by regulatory problems, Citi kept up its consistent profit growth in 2004, but its stock stood still. The firm, along with the rest of the big Wall Street banks, stands to benefit from the flurry of merger and acquisition deals. And Citi is an enormous global player, making it less sensitive to the falling dollar. Bank of America and Morgan Stanley were also mentioned as attractive large-cap companies that currently trade at fairly cheap prices.

Outside the financial sector, several analysts mentioned Wal-Mart Stores as a big company whose stock price has room to grow, especially since the company reported strong December sales. Computer hardware maker Hewlett-Packard Co. also received several nods as a blue-chip stock trading at a modest price compared with its earnings.

Pharma Karma?

While it's perhaps hard to believe, pharmaceutical stocks are also often mentioned as possible surprise winners in 2005, mainly because share prices in the sector have been beaten down so badly in recent months by controversy and recalls.

Merck & Co. was forced to recall its arthritis pain-killing drug Vioxx and saw its stock plunge. Shares in Pfizer Inc. got hammered after the company said one trial indicated its arthritis pain drug Celebrex could raise the risk of heart attack. Market strategists cited both firms as possibly emerging from the doldrums in 2005.

"I think pharmaceuticals could be the big surprise," said Golub of J.P. Morgan. "All the negative news is priced into these stocks. They've just been pummeled to death."

Lisanti of Standard & Poor's, while not especially bullish on Big Pharma, said if the Bush administration succeeds in its efforts to rein in class-action lawsuits, the beleaguered sector could benefit.

Questions Abroad

In addition to loading up on blue-chip, dividend-paying stocks, some strategists and money managers are encouraging investors to increase their exposure to foreign markets in 2005, especially Brazil, Russia, India and China. Investment bank Goldman Sachs has suggested those countries could have four of the world's largest economies by mid-century. Yet stocks of firms based in the BRIC nations remain cheap compared with those of U.S. firms.

"U.S. investors are sorely underweighted in international assets," said Brad Durham of Emerging Portfolio Fund Research in Boston. "We are now in the fourth year in a row of emerging markets outperforming developed markets and yet valuations are still low."

Of course, all four countries face significant obstacles to growth. China needs banking reform, among other things. Investing in Russia means investing in energy, always a risky bet, made more so by a central government that appears less than committed to the free market.

In the end, some of the BRIC countries could falter. So strategists suggest investors slowly build holdings in broad international equity funds or put a little extra cash in funds that invest in individual countries. Exchange-traded funds that include a basket of leading stocks in an individual country are also a good bet.

Rally's Long Legs

In the end, as in any year, unforeseen events such as another terror attack, crisis in the Middle East, a rapid drop in the dollar or a violent plunge in housing prices could derail even the soundest investment strategy in 2005. But barring major shocks, experts expect the market rally born in October 2002 to continue, albeit at a plodding and sometimes infuriating pace. Kind of like 2004.

"It's going to be a good year," said Lisanti of Standard & Poor's. "But it's not going to be a great one. . . . We are well into the third year of the latest bull market, and that is generally a weaker period than the first two years. And there are all these problems that keep hanging around in the background."