Signs of a turnaround are out there

The upside to bear markets and slow economies is that they always hit a bottom. As bleak as things may seem right now -- failing banks, rising unemployment, soaring inflation and spiraling debt -- investment veteran Bill Frels believes that the bottom may finally be in sight.

"We're probably not too far away," said Frels, the CEO and lead portfolio manager of St. Paul-based Mairs and Power. "I think we're probably seeing the worst of it this summer. Things may start looking better later this year and early next year."

The collapse of IndyMac Bank and financial woes at mortgage lenders Fannie Mae and Freddie Mac may evoke comparisons with the bank failures of the Great Depression, but Frels doesn't believe the current problems are as sweeping as some may think.

"People are extrapolating IndyMac's problems to the entire industry. But IndyMac was in the most aggressive portion of the mortgage industry," he said.

"I don't think its situation is representative of most banks in the industry. I really think there's been an overreaction here."

For instance, he believes U.S. Bancorp (USB) still has very solid fundamentals. "Its earnings were down, but it's not in a dire situation. Although it is seeing a deterioration in its mortgage business, the company is prepared to handle it because of the strength of its other businesses."

He concedes that problems may run deeper at Wells Fargo, but says the company is still on solid ground. "Wells is more dependent on the mortgage market than U.S. Bank, but it has not had that much of a problem with subprime mortgages," he said. "The mistake Wells Fargo made was buying home equity loans in the secondary markets, which can be risky."

Perhaps the most compelling story in the local banking market may be TCF. "Unless we're missing something, $10 a share for TCF seems ridiculously cheap," Frels said. "At that price, its dividend yield is 10 percent. The company may not be earning as much as it used to, but it's not losing money, either. Its earnings power is still there. It could even be a good acquisition target in this market."

TCF (TCB) traded Friday at $13.41, down from its 52-week high of $27.95.

Could continued problems at Fannie Mae and Freddie Mac cause a further downward spiral in the financial industry? "I don't think the Fed will let them fail," Frels said. "The government has no choice but to support them."

But there should be limits to the bailout, he said. "There should be some pain and suffering for those who were part and parcel to what happened at Freddie Mac and Fannie Mae. Management was so wrapped up in their stock price performance that they got too aggressive in the mortgage market."

Trolling for bargains

The Dow Jones industrial average is down nearly 20 percent from its peak in October, but some industrial and consumer stocks are down much further. That could represent a great buying opportunity for investors brave enough to buy into a bear market, Frels said.

One example is Toro Co. (TTC), which is down close to 50 percent from its 52-week high. "Its earnings are down, but I don't expect them to drop that much." Frels said the company's significant presence in the international market and its solid pipeline of new products should buoy earnings and the stock price.

Target Corp. (TGT) has also been hammered this year, but Frels expects the stock to bounce back once the economy shows some life. "Right now, Wal-Mart seems to have the upper hand, but that could change. Target is a very well-managed company. It's going through a tough time right now, but it will get through it and it will start to show some growth again."

Target was recently trading at about $47, down about 33 percent from its 52-week high of $69.52.

The other local blue chip Frels sees as a good buying opportunity for those with the patience to ride out the market is 3M Co. "It just hit its 52-week low," he said. "Although its most recent earnings were not what they had projected, they are still reporting continued growth this year. About two-thirds of its sales revenue comes from outside the U.S. I think it has some good growth opportunities ahead."

3M (MMM) is trading at about $69, down 29 percent from its 52-week high of $97. The stock pays a dividend yield of about 3 percent.

Medtronic Inc. (MDT), another local stock in Frels' portfolio, is up slightly this year. "An up stock in a down market doesn't have quite the same growth potential as the rest of the market when the market recovers, but we still think it's an attractive stock. It's a company that continues to grow," he said.

(The Mairs and Power Growth Fund owns the Minnesota stocks mentioned in this column.)

Frels, who has seen a lot of ups and downs in the economy since he entered the financial business in 1962, says he can't pinpoint when the market will turn, but he does expect stocks to start moving up before the economy turns around.

"The stock market is a leading indicator, so it will start to recover before the economy does. I wouldn't be surprised to see the market start to firm up later in the year, with the economy starting to turn around shortly after that."

Gene Walden is the author of more than 20 books about business and investing. He lives in the Twin Cities. Send questions or comments to: gwalden100@comcast.net, or visit Allstarstocks.com.