By Arnie Kaufman
While we at S&P recommend a reduction in equity exposure, that doesn't mean we're no longer bullish on the market. The economy is rebounding nicely from the recession. Corporate profits should start improving shortly. Interest rates and inflation are still low. Sizable cash on the sidelines represents potential fuel for an advance, and investment alternatives to stocks are not particularly appealing at this time.
We have lowered our forecast of where the S&P 500 will end 2002 from 1315 to 1225. But that still represents a gain of 9% in less than nine months.
Risks, however, are high. Escalation of the Israeli-Palestinian conflict or a U.S. attack on Iraq could lead to a major cut in oil availability and surging prices. Each $10-per-barrel rise takes a half percentage point off GDP after two years and adds three quarters of a point to consumer prices, according to S&P chief economist David Wyss.
Along with the possibility of higher energy costs, investors in the period ahead will have to deal with confusing first-quarter earnings reports that mention huge writeoffs of goodwill, the cumulative effect of an accounting change. Balance sheets will continue to undergo intense scrutiny in the wake of recent abuses. Bond yields have been creeping upward, and the Fed seems likely to begin tightening monetary policy in the second half.
S&P chief technical analyst Mark Arbeter sees seasonal influences as an additional concern. He points out that the market generally does much better in the six months November through April than in the May-October stretch.
With stocks today still trading at p-e ratios that are high by historical standards, we suggest lowering the stock portion of portfolios to 60% from 65% and increasing the cash portion to 20% from 15%. Bonds should continue to account for 20%.
Kaufman is editor of Standard & Poor's weekly investing newsletter, The Outlook