Housing Prices Are Way Up, But Experts Disagree on Why

Photo courtesy of thejewishdenver.com

Photo courtesy of thejewishdenver.com

What is driving the recent rapid rise in housing prices? And is this a sign of a sustained economic recovery? Those were among the questions during a segment covering U.S. housing on CNBC May 28 (http://www.cnbc.com/id/100769361). Home prices during the first quarter of 2013 were up by 10.2 percent nationally, according to the S&P/Case-Shiller Index, the highest since 2007. Phoenix and Las Vegas, two of the regions hit hardest by the recession, were up the most.

Experts point to the very low mortgage rates (held artificially low by the Fed) and the low inventory of houses as among the reasons for the increase. Very few new houses are being built so sales are cutting into the inventory, increasing demand for the few left for sale.

Those who believe the housing market will continue to prosper say population growth will be a driver: One million new households a year are being created. Naysayers, who believe the price increases are not sustainable, say the market is being driven by investors who are buying and renting. They also point to still low construction employment numbers and the fact that college graduates, who should be a major factor in first time homebuyers, are not getting jobs and are shackled with $1 trillion in student loan debt.

While there is little doubt that houses are being appraised at higher prices, the small cap home builders, who had been on a tear since last summer, have seen their valuations flatten out. Here is an update on the home builders we have been following for the past year:

Red Bank, NJ-based Hovnanian Enterprises (NYSE: HOV, http://www.khov.com/) specializes in single-family detached homes, condominiums and town homes and operates in two segments: homebuilding and financial services.  As recently as October 2011 HOV was trading for $0.89. But since March HOV has been hovering around the $6 mark. HOV closed May 28 at $6.15, up 11 cents for the day with a market cap of $856 million. Its 52-week trading range is $1.52-$7.43.

Los Angeles-based KB Home (NYSE: KBH, http://www.kbhome.com/) is a home building and financial services company catering in large part to first time buyers. KB is an old Southern California home builder, founded in 1957 and formerly called Kaufman and Broad. As recently as last Aug. 31 KBH traded for $11.04 with a market cap of $851 million. It closed May 28 at $23.16, up 5 cents for the day with a market cap of $1.9 billion. Its 52-week trading range is $6.46-$25.14.

Columbus, OH-based M/I Homes Inc. (NYSE: MHO, http://www.mihomes.com/) builds single family homes primarily in the Midwest, Mid-Atlantic and southern parts of the U.S. The  company was founded in 1973 and, like most of the other builders, has homebuilding and financial services divisions. It also had a run up into March and closed March 20 at $26.03 with a market cap of $584 million. MHO closed May 28 at $26.47, up 29 cents for the day. Its 52-week trading range is $12.24-$29.07.

Atlanta-based Beazer Homes USA (NYSE: BZH, http://www.beazer.com/) builds and sells single-family and multiple-family homes in 16 states in the U.S. It also acquires, improves and rents homes. The company operates through commissioned home sales counselors and independent brokers. Back in mid-September BZH was trading for $3.77. It closed March 20 at $16.86 with a market cap of $410 million. On May 28, BZH closed at $21.79, up 44 cents for the day, with a market cap of $547 million. Its 52-week trading range is $3.46-$23.29.

Irvine, CA-based Standard Pacific (NYSE: SPF, http://www.standardpacifichomes.com/) builds single family and detached homes and targets a wide range of homebuyers. It also provides mortage financing services through its mortage finance subsidiary, Standard Pacific Mortgage. SPF closed March 20 at $9.07 with a market cap of $1.9 billion. It closed May 28 at $9.52 down 16 cents with a market cap of $2.1 billion. Its 52-week range is $4.39-$9.97.

Westlake Village, CA-based The Ryland Group (NYSE: RYL, http://www.ryland.com/) is a homebuilder and mortage finance company. RYL covers many aspects of the home buying process including design, construction, title insurance and escrow. RYL closed March 20 at $42.16 with a market cap of $1.9 billion. It closed May 28 at $47.60, down 86 cents, with a market cap of $2.2 billion. Its 52-week trading range is $19.25-$50.42.

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Turnaround in Housing Market, Low Inventory Causing ‘Bubblelike Price Jumps’

Photo courtesy ownthedollar.com

Photo courtesy ownthedollar.com

Home construction was an important topic this week, with the release of data showing construction on new U.S. homes in February showed “gains for single family residences and apartments as longer-term trends signaled a housing market that continued to strengthen,” according to the Wall Street Jounal’s Market Watch.

In fact, the turnaround in the housing market, after so many months of lagging demand, has caught home builders off guard, according to the New York Times (http://www.nytimes.com/2013/03/21/business/economy/in-us-surprise-housing-demand-catches-industry-off-guard.html?ref=business&_r=0). “After six years of waiting on the sidelines, newly eager home buyers across the country are discovering that there are not enough houses for sale to accommodate the recent flush of demand,” noted the Times report.

That’s leading a rush for the new but still limited inventory and “bubblelike price jumps” in areas that have been hit hard in recent years. Standard & Poor’s Case-Shiller index shows that prices nationwide rose 7.3 percent throughout 2012 but in places like Sacramento, CA and Phoenix, the prices have risen 35 percent and 26 percent, respectively. Part of what’s driving the market is the improved economy, but the low interest rates are also playing an important role, noted experts in the Times story.

Certainly this is great news for investors in small cap housing stocks, who have already enjoyed a great return if they invested last Fall. Their only issue now is whether to sell and take some profits or continue to enjoy the rise.

Here are six small cap home builders we last covered Sept. 14:

Red Bank, NJ-based Hovnanian Enterprises (NYSE: HOV, http://www.khov.com/) specializes in single-family detached homes, condominiums and town homes and operates in two segments: homebuilding and financial services.  In October 2011 HOV was trading for $0.89. By Sept. 14, 2012 it had jumped to $3.89, with a market cap of $515 million. HOV closed March 20 at $6.32, up 13 cents for the day. HOV’s market cap is now $879 million and 52-week trading range is $1.52-$7.43.

Los Angeles-based KB Home (NYSE: KBH, http://www.kbhome.com/) is a home building and financial services company catering in large part to first time buyers. KB is an old Southern California home builder, founded in 1957 and formerly called Kaufman and Broad. Back on Aug. 31 KBH closed at $11.04 with a market cap of $851 million. It closed Sept. 14 at $13.65, pushing its market cap up to $1.05 billion. KBH closed March 20 at $21.57, up 54 cents with a market cap of $1.67 billion. Its 52-week trading range is $6.46-$21.79.

Columbus, OH-based M/I Homes Inc. (NYSE: MHO, http://www.mihomes.com/) builds single family homes primarily in the Midwest, Mid-Atlantic and southern parts of the U.S. The  company was founded in 1973 and, like most of the other builders, has homebuilding and financial services divisions. It closed Sept. 14 at $20.77, with a market cap of $379 million. MHO closed March 20 at $26.03, up 86 cents on the day, and now has a market cap of $584 million. Its 52-week trading range is $11.25-$29.07.

Atlanta-based Beazer Homes USA (NYSE: BZH, http://www.beazer.com/) builds and sells single-family and multiple-family homes in 16 states in the U.S. It also acquires, improves and rents homes. The company operates through commissioned home sales counselors and independent brokers. At the close on Sept. 14 BZH was trading for $3.77. It closed March 20 at $16.86, up 19 cents for the day, with a market cap of $410 million. Its 52-week trading range is $10-90-$20.15.

Irvine, CA-based Standard Pacific (NYSE: SPF, http://www.standardpacifichomes.com/) builds single family and detached homes and targets a wide range of homebuyers. It also provides mortage financing services through its mortage finance subsidiary, Standard Pacific Mortgage. SPF closed Sept. 14 at $7.46, up 19 cents for the day and setting a new 52-week high, with a market cap of $1.49 billion. It closed March 20 at $9.07, up 35 cents for the day, with a market cap of $1.9 billion. Its 52-week range is $4.12-$9.18.

Westlake Village, CA-based The Ryland Group (NYSE: RYL, http://www.ryland.com/) is a homebuilder and mortage finance company. RYL covers many aspects of the home buying process including design, construction, title insurance and escrow. It closed Sept. 14 at $31.52, also setting a new 52-week high, with a market cap of $1.41 billion. RYL closed March 20 at $42.16, up $1.61 for the day, with a market cap of $1.9 billion. Its 52-week trading range is $17.18-$43.

David Fondrie from Heartland Advisors: A Glass-Half-Full Guy Looks at the Sequester and Economic Growth

David Fondrie is a Senior Vice President and Portfolio Manager for the Select Value Fund at Heartland Advisors in Milwaukee (www.heartlandfunds.com).   He joined Heartland in 1994 and subsequently served as Heartland’s Director of Equity Research for ten years from 2001 to 2011.  He also held the position of CEO of Heartland Funds from 2006 to 2012.  He’s a Badger from the University of Wisconsin and served with the armed forces in Korea.  He started his career with Price Waterhouse and is a CPA.  Our paths have crossed repeatedly over the years since we had interests in some of the same companies.  Like many Midwesterners, he is a plain-spoken man.

Dave Fondrie, Heartland Advisors Inc

Dave Fondrie, Heartland Advisors Inc

We had an opportunity to chat on March 1, the day the much-discussed government spending sequester went into effect, and I asked him what he thought would happen as a result.

DF:  The headline effect is likely to be worse than the real effect.  It’s not going to be as devastating as the articles in the press would have us believe.  There will no doubt be some pain inflicted on defense stocks, for instance.  But for the most part people have been expecting this to happen, so it is not a surprise, and it is built into the market.  There are too many green shoots in the economy now for something like the sequester to knock them all down.

JA:  Are you seeing it more like a speed bump than a brick wall?

DF: Yes, exactly.  I think Congress will get around to the budget and the cuts, adjusting them to what makes more sense.  If you look around at the United States economy right now, what is striking is what is going on in the oil and gas field.  Suddenly we are one of the lowest-cost energy producers and consumers in the world.  Not only does that have a direct effect on business, it is creating a new industry that is building out the infrastructure that will allow us to provide low-cost natural gas energy to industrial America.  This has put us in quite a positive situation.

We are paying $3.50 for natural gas, where Europe is paying $12.00 and Japan is paying  $16.00.  So to me that means that companies that rely on energy for their operations are much better off here than in other major developed economies around the world.  A steel forge, for instance or a company like Precision Castparts Corp (PCP), which use enormous amounts of energy in making parts, are a lot better off here than anywhere else.  Fertilizer plants.  The renaissance in chemicals here is extraordinary.  There are 12 new ammonia plants on the drawing boards, and they all will have a reliable and lowcost stream of natural gas as both energy and raw material.  We can use that ammonia domestically and stop importing it from other economies.

LNG.  There are a number of proposals for LNG plants.  These days we are talking about exporting LNG, where we never thought about anything but importing it in years gone by.  I think this low-cost energy source is underappreciated.  In fact it will spur the continued development of oil and gas, infrastructure, chemical plants, and other types of industrial expansion.   All of that is good for the economy.  Add to that some continued improvement in employment and housing, with home prices increasing, and we foresee stronger consumer confidence, especially as a result of higher home prices.  Already 401(k) values have been improving, and it is undeniable that we are in a low interest-rate environment as well.

All this headline talk about the sequester risk is overblown.  There is no doubt that federal spending and the size of the national debt have to be brought under control.  Entitlement plans have to be rationalized.  But add to the overall situation the fact that China is clearly recovering.  Chinese electrical usage is up, their industrial consumption of materials and energy is up, and as China grows, their growth is good for the other economies that feed her growth.  Europe is not likely to get any worse.

We’re looking for 2.5% to 3% GDP growth in 2013.  The stock markets continue to be reasonably valued.  Corporate balance sheets are good; earnings are good and continuing to improve modestly.  The S&P 500 is trading at 14 times earnings, where in the past it has traded at an average of 16 times earnings.

The wild card is what happens with interest rates.  People have not yet abandoned bonds, but the inflows have receded after several years.  There have been outflows from the equity markets for five years.  Now we are seeing a trickle-back return to the equity markets.  Sadly there is a pattern that is repeating itself, with many buyers entering at the midpoint of an equity run, not at the beginning.  But this is the way cycles go.  We are in the 4th or 5th inning if you take a long view of this bull market over the last three years.

JA:  So are you buying energy companies?

DF:  Not particularly.  Low energy prices are not particularly favorable for exploration and production companies.  But we are looking closely and buying companies that supply goods and services to the energy patch.  For the last two or three years, for instance, it has been apparent that there will have to continue to be huge investments in the energy patch.  If you are drilling in North Dakota, you may have no infrastructure to bring the liquids you are pumping to the refineries, which all tend to be downriver by quite a distance.  We have huge backups in Oklahoma because there is not enough pipeline to carry all the energy.  One company we have owned for 2 to 3 years is Mas Tec Inc (MTZ).  We bought it in the 12s and it closed Friday at $30.78.  Part of their business is in pipelines, and they have also done well at the gathering systems in areas where energy is being produced at the wellhead.  Those are both high-growth areas; the stock was trading cheap two years ago, and it has given us a reward.  Quanta Services Inc (PWR) is very much the same story – we used to own that stock as well, but we sold it when its valuation reached what we thought was a sensible level; in their case they are exposed to pipeline development and new high-voltage lines.

JA:  How about life sciences companies?

DF:  The FDA has been problematic as they have increased their oversight of the industry resulting in complex regulations and inspection observations (commonly called 483 observations).   We own Hospira Inc (HSP), which was a spinout a few years back from Abbott Laboratories  (ABT).  They have run awry of the FDA at a manufacturing facility in Rocky Mount, North Carolina.  In Hospira’s case, addressing the 483 observations and revising processes and procedures has resulted in over $300 million in costs and reduced output of drugs that are already in short supply.  We are all concerned with safety; however those concerns should be balanced with a sensible and timely regulatory process.

JA: Does that put a caution flag out?

DF:  I can’t speculate on what kinds of furloughs the FDA will have to put into effect.   I doubt that we will have chickens rotting on processing lines waiting for FDA inspectors as the press and certain congressional members have suggested, but the big issues around drug approvals will continue to be important, and is likely to be slowed down even further with the automatic budget cuts.  Hopefully they will prioritize their cutbacks and the expense reductions will have less impact than we might expect.  But government does not always work very efficiently.  We hope they will be smart and furlough the poor performers instead of just following  a LIFO pattern.

JA:  How do you feel about ObamaCare and stocks?

DF:  I do sense that there is a bit more thought being given to the impact of ObamaCare.  We just reviewed the 2014 Medicare Advantage benchmark payment rates by the Centers for Medicare and Medicaid Services (CMS), and the cuts were more draconian than expected.  But the government was clear that they are not trying to cripple the HMOs because they are a vital part of the new program.  I am a glass-half-full guy most of the time, and I think if people sit down and talk they can get to some reasonable results; let’s hope that happens.  There is always give-and-take with reimbursement rates, and they end up meeting someplace in the middle.  US businesses are resilient; once they know where the boundaries are, what the rules are, they adjust.  What happens is what you expect in a capitalist system: change comes quickly.  Capitalism works pretty well.

JA:  Where do you think people ought to be looking in the equity markets this year?

DF:  I am in the camp that says we will continue to have a modest economic recovery.  In that kind of environment you have to look at cyclical companies.  We are overweight in industrials and information technology companies.  Everyone is going to look at productivity, and technology is important there.  People will continue to invest in technology to improve productivity.  We are going to be hooking up all kinds of machines at home and in factories to the Internet.  We think tech plays work.  We might stay away from actual PCs, but mobility will continue to expand, and downloads will continue to grow, keeping  Internet growth robust.  Probably financials are good, due in large part to a stronger housing market.  We are a little more cautious on that because the interest rate environment does not allow much net interest rate gain to banks.  But housing will drive loan growth, and the banks have plenty of capital to lend.  With business loans at 3.5%, it is hard for banks to make money.  If we got an uptick of half a percent, it would do wonders.

In tech companies, we like Cisco Systems Inc (CSCO).  We see Cisco as a chief enabler of the infrastructure of the Internet.  Cloud computing is driving a lot of internet traffic.  Cisco is cheap at 12 times earnings, and there is that nice dividend yield of 3% too.  The balance sheet is pristine; altogether it is a very attractive risk-reward proposition.  I run a value-oriented multicap fund.  Cisco is seen as a growth stock, but right now it is also a value stock.  They have gotten their act together after some unwise acquisitions a few years back; we think the downside is minimal.

JA:  What about social media?

DF:  Social media doesn’t really fit our style.  Even Google is not in an area where we play.  Thematically I like agricultural plays like Archer Daniels Midland Company (ADM).  It is trading a bit above book value, and the dividend yield is 2.4%.  If we have a big corn crop, ADM is going to benefit from processing all that corn.  I believe we will have a big corn crop this year, and we need one.  ADM’s PE is under the S&P 500.  I can’t predict the weather, but we are getting moisture that we badly need in the Midwest, so the water table can support strong crops this year.  We’re looking at fertilizer companies, seed companies, and farm equipment (especially on a dip).  Railroads are a bit expensive right now, but it is worth noting that the number of rail cars carrying oil is growing at 25%, which makes those cars part of the infrastructure for moving energy.  Oil companies and refiners are buying those cars and the rails are moving them.  We’ll buy rails on dips too.

One final area that is more in the later innings is deepwater offshore.  We are particularly interested in drilling off the east and west coasts of Africa.  We like the companies that build out those platforms and subsea infrastructure to bring that oil to market.  We like the boat companies that service those rigs.  These are long-cycle investments; the big international oil companies don’t start-and-stop those projects.

JA:  What about shipping companies?

DF:  There may be too much capacity there.  OSG went bankrupt.  What has happened in the US is that we are importing less oil than we were five years ago, and the amount we are producing here has increased.  Our demand for oil from overseas has decreased.  So tanker ship demand has decreased as well.  If China starts to really boom again, that could absorb some of the excess capacity, but I don’t see that as near-term.

JA:  How about the greenback?

DF: The euro is at risk, but the dollar should hold its own.  If the Chinese let their currency float more that might affect the dollar, but for now the dollar is fine.

JA:  Is there an upside to the 2.5% to 3% GDP growth you mentioned?

DF:  Maybe in the back half.  If we resolve our government problems, that might restore more confidence.

JA:  Thanks, Dave.

Allen & Caron owns none of the stocks mentioned in this interview, and Joe Allen owns none of the stocks mentioned in his personal accounts.  Please do your own research.  JA

Buzz Zaino: Royce Fund Manager Sees Strong Growth Upside for 2013, Boosted by Housing, Transportation, IT Spending

ZainoB_gBoniface A. (“Buzz”) Zaino is a portfolio manager advising several of the high-profile Royce Funds, to wit, the Royce Opportunity Fund and associated funds. By any measure a veteran of the industry, Buzz has more than 40 years of experience in the financial services industry, the last 14 with Royce. I first met him when he was managing the Value Added Funds for Trust Company of the West more than 20 years ago, but prior to that he was president of the Lehman Capital Fund and a principal of the “original” Lehman Brothers. He went to school at Fordham, and took his MBA from Columbia. In 44 years, Buzz has seen enough economic cycles to offer an MBA from the University of Zaino.

Buzz agreed to talk about his 2013 outlook from his home in Aspen which, like much of the US snow belt, has seen little of the white stuff so far this year.

JA: It seems generally agreed that the US economy is growing at a slower pace than it has coming out of previous recessionary periods. What is your outlook for 2013? Will the economy continue to grow, and if so, will it grow at the same rate, faster or slower?

BZ: The reason that the US economy has had a slow lift-off has been that coming out of recessions in the past, the Fed has lowered interest rates, and people took that opportunity to buy houses and cars. This recession was different, because the banks were not giving out money, because money was scarcer and because bank lending standards were significantly more stringent. So there was a hiatus and it took a lot longer for the economy to recover. The recovery finally started this year, 2012, and it is finally beginning to give a boost to the economy, especially as construction gets going again. That boost is going to continue, and it will help us accelerate in 2013. But the recovery was complicated by the fact that Europe went into recession. American companies tend to be worldwide in scope, and caution at the top levels helped bring inventory levels down due to the European recession. That meant that capital spending was also muted. I think that capital spending is also constrained in anticipation of the budget settlement that is still out in the future. A “normal” recovery was delayed until 2012, and then delayed again by the European recession. But those delays now give us the opportunity to accelerate as 2013 progresses.

JA: Will we get a budget?

BZ: Sooner or later, yes. We will get a budget deal out of Congress. Once we have that deal defined, we can go forward from there. That will be a positive, and will be on top of the acceleration we can expect from normal factors like housing and auto sales. We could get a nice surprise in 2013. But we’re cautious about January.

JA: Why is that?

BZ: Most managers will make their January decisions based on their December orderbooks, and we don’t think the December orderbooks will be strong enough to give them confidence, but as we go into February and March, a lot of the inventory build-up will have started to occur, so the orderbooks will look better. And the trade between China and the US is expanding again, after a period of slower growth. We think that could have an increasing effect, especially after the Lunar New Year. By the end of the first quarter, growth could be looking quite good.

JA: The harsh talk by Washington DC and Beijing won’t slow down that growth?

BZ: The China-US trade is too big a market for both sides, and politics will not interfere with it. Certainly the Chinese government’s expansion plans are not going to be held back. There are Chinese hotel companies looking for hotel properties in the US – to build or to buy. Very smart people, and I don’t think either side is going to let politics inhibit our trade relationships. Nothing is going to come of the yelling.

JA: Will the growth rate be higher going into the second quarter then?

BZ: I think we could have a weak-ish economy and market in January, like I said. Everyone will be paying higher taxes, at least with FICA deductions back in everybody’s paychecks. With orderbooks in December that may not be strong, managers and consumers could still have their hands in their pockets. If we have a warm winter like we had last year, we could have more construction starts. If we have a cold, snowy winter, those starts could be delayed, and the weak period could extend through January. We are looking very favorably at housing. Housing is still somewhat depressed, but the housing stock is aging — and mortgage money is more available than it was a year ago. And the automobile fleet is aging and will need to be updated, as will the commercial truck fleet.

JA: Do you think the growth rate will exceed 2%?

BZ: Yes, better than 2%, but maybe not in January. But after that it could be substantially more than 2%. Four to five percent would not be out of the ballpark, although 5% would be at the high end of probability. And the market would react to that. If the market is down – and cheap – they don’t want to buy, but if it goes up 15%, everybody wants to buy. If UPS starts to replace its fleet and buys trucks, all the others will update their fleets at the same time. It’s much cheaper to run your truck or your fleet on CNG (compressed natural gas) too. A town near Aspen has converted their entire bus fleet to CNG, and although they can fuel up at the bus barn, there are additional CNG stations being built. Boone Pickens and his group are encouraging these new CNG fueling stations. We’re surprised that trucking companies are not moving faster than they are toward natural gas. We have an investment in a building materials company and I asked them if they are considering CNG, and they said they had not looked into it, but they would. Conversions to CNG are not expensive. Ford and GM are now offering pickup trucks with CNG engines.

JA: Is there going to be a fiscal cliff solution?

BZ: Eventually. Whether or not it happens before December 31, there’s no way to tell. But the congress can pass a continuing resolution to postpone the cuts and tax increases while they work on it. Eventually this Mexican standoff will be resolved. And by the way, the fiscal cliff does not seem to be a big motivator for the American consumer. They need to replace things, and they are not overly concerned with the big picture as long as the economy seems to be getting healthier.

JA: What sectors are going to do better as the economy improves?

BZ: IT spending will pick up. There is a big pent-up need factor here, and it has been a relatively easy way to postpone expenditures for the last couple of years. Windows 8 is very much under-rated. It takes a while for people and corporations to decide to make a big change like the change to Windows 8, but it will be very good for PC companies. Corporations need to have the latest and fastest. Technology in corporate environments needs to be the newest and most capable. Areas like IT are why you can think of higher growth rates. After this hiatus, there is enough pent-up need to start a new momentum.

JA: How about healthcare IT?

BZ: I went to see my physician in New York, and he is one of the best, highest-rated doctors in his specialty. He was really annoyed that he was going to have to convert my file, which is a manila folder with all kinds of paper and bits of paper in it – to computer files. I thought, hey, this is 2012, get with the plan.

JA: How about housing? Any areas there where investors ought to be looking?

BZ: We have had a good run with housing companies, and we think that will continue. One area that may have real potential is mortgage insurance companies. It is a fairly narrow field, and some people infer from the papers that these companies may not be able to cover their losses. The reality is that housing prices could be moving up at a rate of nearly 1% per month in the near future, and as a result those liabilities would be decreasing. Mortgage applications for refinancing were up last week 47% year over year. That’s a meaningful number. Apparently not everyone is under water. Those areas that have dropped the most are improving the fastest in some cases. California is one of those.

JA: Any areas where you would be wary going forward?

BZ: Defense companies. We think there will be lots of cutbacks, lots of programs cancelled. Defense personnel contractors may do better as the armed services cut back their personnel. Company by company there may be some good bets in defense, but we believe the sector will be down.

JA: And in summary?

BZ: Other than defense, it is going to be a broad-based recovery. If we have a growing, recovering economy, interest rates would rise, and inflation would rise. Commercial banks will do better. They will use their asset bases to increase lending. The moderating factor will be that regulations will add some cost, but that will not be an inhibitor for the larger banks looking to expand regionally. If I were a larger bank and wanted to expand regionally, it would be attractive to me to buy a regional bank and expand my profitability without appreciably expanding my regulatory exposure.

JA: Thanks, Buzz.

Note: Buzz prefers not to name specific companies in his portfolios. The interviewer has no investments in the sectors discussed, and does not intend to initiate such investments in the next few days or weeks.