SIVY ON STOCKS from CNNmoney.com
October 17, 2001

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Surprise me

The big surprise this week is that
earnings are coming in slightly better
than expected.

NEW YORK (CNNmoney) - The great
thing about unrelenting pessimism is that
any surprises are likely to be pleasant
ones. That's pretty much the point
investors reached after the Sept. 11
attacks. Expectations for third-quarter
profits are now so negative that even mediocre reports count
as good news. In fact, the results that have come out in the
past few days -- particularly for some of the financials and
drug companies -- are better than mediocre.

I continue to be somewhat more optimistic than many
economists. I believe that the Federal Reserve's enormous
interest-rate cuts will fuel an upturn in the economy -- and
that the rate cuts would already be taking effect were it not
for the economic damage stemming from Sept. 11. Fears of
further terrorism continue to undermine the market,
overshadowing faint signs of improving fundamentals. As a
result, the Dow was down 151 points on Wednesday, despite
several strong earnings reports.

Freddie Mac (FRE: down $0.44 to $66.65, Research,
Estimates)  reported a 26 percent earnings gain for the third
quarter. That follows Fannie Mae's (FNM: down $0.73 to
$80.85, Research, Estimates)  strong report, which I
discussed in Monday's column (see "A lender's market").
Citigroup (C: up $0.47 to $46.56, Research, Estimates)
announced a 9 percent decline in third-quarter earnings after
expenses related to last month's attacks. Without the
unexpected charges, Citigroup would have posted a
double-digit gain, and the company projects 15 percent
growth in the fourth quarter. J.P. Morgan Chase (JPM: up
$0.66 to $34.60, Research, Estimates) announced a 68
percent drop in earnings -- but the results were in line with
analysts' reduced forecasts.

The strongest sector this fall may well turn out to be
pharmaceuticals. Two leading companies reported strong
results on Wednesday. Pfizer, the world's leading drugmaker,
turned in a stunning 28 percent profit gain for the third
quarter, confirming the company's status as the must-own
choice in the industry. Blockbuster products such as
anti-cholesterol drug Lipitor helped fuel sales, while cost
cutting in the wake of last year's Warner-Lambert acquisition
bolstered profit margins. Solid but less flamboyant gains were
announced by Johnson & Johnson, where third-quarter
earnings gained nearly 16 percent.

A few bright spots don't add up to a fireworks display, but
there are two pieces of conventional wisdom worth keeping in
mind right now. The first is that the direction of the market
depends on how profit trends compare with expectations.
The bad news has already been factored into stock prices.
What matters from here on is not whether results are good,
but whether they're not as bad as feared.

The other fact to remember is the importance of
diversification. The greatest upside leverage when the
economy recovers will probably be among the big-cap tech
stocks. But drug stocks are equally important parts of a
well-balanced growth portfolio.

J&J's (JNJ: up $1.00 to $57.77, Research, Estimates)  13
percent long-term annual growth rate and broad
diversification within health-care makes it an appealing choice
for conservative investors. At $58 a share, the stock trades
at 26 times next year's projected results. But it may be
smarter to pay up a little more for Pfizer (PFE: up $0.55 to
$41.65, Research, Estimates). At $41.65, the shares are
trading at 28 times projected earnings for 2002. That's not a
cheap P/E, but it's a small premium to pay for the No. 1
company in the industry with a core growth rate of nearly 20
percent a year.

###

Read all of Michael's columns at:
http://money.cnn.com/markets/sivy/

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