The Guest Blog

Farrell: What Did Ben Say?

Federal Reserve Bank Chairman Ben Bernanke
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Time magazine's Man of the Year Ben Bernanke gave a speech this past weekend, and at first I thought he was defending the excessively loose monetary policy that led to the recent crisis.

It sure sounded that way when he said that easy money did not cause the housing bubble. He defended his statement by saying yadda, yadda, yadda; beep, beep, beep; and a little of this and a little of that. He has to have been kidding!

Like Goldman's Blankfein was when he said investment banks do God's work. (He was kidding, wasn't he?) But I felt better when I saw that Ben, as the Monday edition of the Wall Street Journal headlined, "Edged Closer to Using Rates to Pop Bubbles." "We must be especially vigilant," said the Fed chief, " in ensuring that the recent experiences are not repeated." Better regulation is Ben's first line of defense (yeah, right!), but the Fed needs to "remain open" to use the "blunt tool" of higher interest rates to avert or pop asset bubbles. He further said the Fed would need to begin withdrawing its stimulus from the economy "well before" it has returned to full strength.

To me that's another arrow in the quiver of the argument that the Fed will begin to withdraw liquidity sooner rather than later via the unconventional vehicles it has been setting up. That, and some healthy economic reports, sent the market flying for the first day of the New Year. The ISM (Institute of Supply Management) survey for December rose to 55.9 from 53.6 last month (above 50 is expansion). This is the fifth straight month in a row of a reading above 50. The "new orders" and "production" sub-indices both went above 60. The "supplier delivery" number went to 56.6 from 55.7, which is good since it means suppliers are busy and it takes them longer to fulfill orders. The only fly in the ointment was the "prices paid" component also went above 60, which could mean more inflation down the road—and possibly the need for the Fed to act against that inflation.

China reported two different manufacturing PMI's (Purchasing Manufacturers Index). The official one rose to 56.6 vs. 55.2 in November. The Markit PMI (private survey) also rose to 56.1. Germany (52.7 last reading), France (54.7), Italy (50.8), and the UK (54.1) all look like the manufacturing sector is picking up (and thanks Jason Trennert for those stats). So good economic reports, plus a Fed that, to me at least, is saying we're nervous and might have to act on rates (rising rates can indicate better economies) led to a wonderful first day in the market. Volume was light but I think you all are sick of me saying that. Naturally, with the thought of stronger economic growth, both gold and oil moved up. But it's worth noting that outside of energy and material stocks outperforming the market, financials and health care did as well. There is an old school of thought that a market cannot act well without financials doing well. So I am glad they did.

And speaking of health care (clever segue, huh?), A.J. Rice, one of Soleil's health care analysts, offered five stocks for 2010. He and his faithful associate, Chris Rigg, are "generally optimistic" for a number of health care segments. Key provisions in health reform proposals have been pushed out to 2012 and beyond. That would allow the industry time to adapt and/or lobby for changes. A.J. believes that the Congress will pass health reform by President's Day but after that the Washington backdrop should settle down (i.e., little else is likely to happen on health care this year, other than probably some minor changes in reimbursement rules favorable for doctors - a potential positive) as the focus shifts to the mid-term elections in the fall.

Baby boomers hit 65 this year (I wish everyone would shut up about that), and their demand for services will grow. We all know that, but the focus has been crowded out of the discussion for the last two years. But there are countervailing trends, like state budgetary constraints which could, says A.J., hurt sectors like nursing homes and behavioral health centers. He likes the hospital group still since quarterly earnings comparisons should be easy in the early part of the year. The Washington backdrop is somewhat favorable and cost trends remain under control. He is recommending Community Health (CYH; Buy-rated; recent price $36.08). The company's had strong physician recruitment the last two years, the next two quarters represent easy comparisons, and CYH's strong cash flow can be used for debt pay-down or acquisitions. His 12-month target price is $44, or 15 times his 2010 estimate. 15 times is well within historical valuation parameters.

Lincare Holdings (LNCR; Buy-rated; recent price $37.94) operates in the home oxygen segment of health care. Medicare reimbursement is clear for the first time in five years, demand remains strong with an aging population, and the company generates significant cash. Target price is $43, which would be 17.5 times his 2010 estimate. Patterson Companies (PDCO; Buy-rated; recent price $28.81) is one of the largest dental equipment distributors. An economic recovery could drive a strong upturn in their business, and the 15% of their business that is veterinary distribution is already seeing better signs. The company generates strong cash flow, and A.J. thinks it's worth $34.50, which would mean a multiple of 18 times his fiscal 2010 estimate.

Positioning Your Portfolio

Coincidentally, my good friend, Michael Farr, of Farr Miller, and I were on CNBC together the other day and Patterson is one of his ten stock picks for 2010.

Select Medical (SEM; Buy-rated; recent price $10.75) operates specialty hospitals and outpatient rehab centers. Medicare reimbursement looks steady through 2012 and their acquisition activity should pick up. Fair value, says A.J., is 10 times EBITDA, or $14. His last of the honored five is Service Corporation (SCI; Buy-rated; recent price $8.31). The negative effects of the economic slowdown are reversing and pre-need cemetery sales are up year-over-year. The company, like all these picks, has strong cash flow and A.J. thinks a 12-month target price of $11 based on a free cash flow yield of 9% makes sense.

Vincent Farrell, Jr. is chief investment officer at Soleil Securities Group and a regular contributor to CNBC.