Gathering Strength For A Fresh Charge?
Are the stock market's recent gyrations its death throes--or merely a bull market catching its breath before soaring to new highs? For an answer to that question, BUSINESS WEEK turned to last year's forecasting stars, the market strategists who came the closest to calling the Dow's rise in BUSINESS WEEK's annual Market Forecast Survey for 1996. According to many of these market pros, the bull is far from dead.
Most of 1996's top forecasters are sticking to their guns, even though the Federal Reserve raised rates sooner and with less evidence of inflationary pressure than many expected. Far from cutting back their 1997 forecasts, some of the pros are even raising yearend targets. These gurus say that the market's recent decline, with the Dow Jones industrial average suffering as much as an 8.6% drop from its March peak, and the Standard & Poor's 500-stock index falling 10% from its February high, is not the start of a long-term bear market. It is, they say, a short interruption in the bull's advance. Most of them are forecasting that the combination of solid earnings and low inflation will shepherd the Dow and the S&P 500 to healthy, if not spectacular, gains in 1997.
CHANGE OF TUNE. The Dow's big downdraft came as no surprise to Robert F. Dickey, technical analyst at Dain Bosworth Inc. in Minneapolis. Dickey was the winning strategist in BUSINESS WEEK's 1996 survey. He had the highest Dow forecast, at 6300, and came the closest to predicting the Dow's 26% rise last year. By late 1996, Dickey was singing a very different tune, saying that the market was close to a correction and that higher inflation would hurt interest rates and drag down stocks and bonds.
Now, Dickey's mood is less dour: Instead of sticking with his forecast of a Dow at 4400 by yearend, he now thinks it could close between 5500 and 6000. "It's a correction, not a bear market," says Dickey. "That means it will be short-lived."
Dickey was the most prescient guru in the 1996 survey, but the most closely watched strategist is longtime bull Abby Joseph Cohen of Goldman, Sachs & Co. Cohen expects the Dow to rise about 10% in 1997, in line with earnings. "My forecast is still for a Dow of 7050 by yearend," she says. The "ugly economic conditions" that typically accompany a bear market simply aren't here, says Cohen. "We have an economy doing very well, thank you very much, inflation that is very much under control, and we have a Fed deciding to raise rates now in an attempt to preempt inflation in the future."
Interest rates have to rise very dramatically to have much impact on profit growth, says Cohen. She doesn't think the rise in rates in 1997 will be "dramatic enough to bring us into recession or cause a dramatic change in the cost structure of most companies." The yield on the 30-year Treasury, which stood at 7.1% on Apr. 9, could go up a little more, but economists at Goldman, Sachs think the 1997 rise in the long bond's yield is about over.
Gruntal & Co.'s Joseph V. Battipaglia is another steadfast bull who is holding to his yearend forecast. The market has had a correction, he says. But "relatively low inflation, solid economic growth, and at least a 10% expansion in corporate profits should bring us to roughly 7000 by yearend," says Battipaglia. Since rampant bullishness would be a contrary indicator, he thinks that "the mood in the market is perfect for a rally--gloom, doom, and the gnashing of teeth."
With the window for initial public offerings closed, investors should focus their attention on small- and mid-cap stocks that have gone wanting since last summer, says Battipaglia. "The easy decision has been to index your money using the Standard & Poor's 500-stock index or to play the IPO sweepstakes," he says. The Dow may have a 10% year in 1997, but "the real action will be in the broader indexes of smaller stocks such as the Russell 2000."
Strategists agree that what happens to the inflation rate will determine the path that the market takes. With inflation at about 3% and the Federal Funds rate at 5.5%, it shouldn't take much to slow growth in the GDP down, says Jeffrey M. Applegate, chief investment strategist at Lehman Brothers Inc. "Our sense is that the bulk of the correction is behind us," he says. "Peak to trough, it was 10%, and we could revisit that and maybe a little more, but I don't think we'll pile on another 10%."
LONGER CYCLE. Applegate's latest report to clients focuses on what the rebound in the market is likely to be. He looked back at the five prior corrections that took place in long-cycle environments, when the Fed was trying to slow GDP but not bring on a recession. Applegate found that the market corrected, the Fed slowed GDP and thus extended the earnings cycle, and the stock market's average rebound one year after the trough was reached was 30%. If the Fed manages to slow GDP growth, the multiple expansion in the stock market could bring it to a yearend target of 7400 to 7800, he says.
Another bullish voice belongs to Robinson-Humphrey Co.'s Robert S. Robbins. "There is an excellent chance that we've seen the low of this correction," he says. "In superbull markets like this, you don't get corrections over 11% unless something horrible happens like the Persian Gulf War with oil prices doubling." Oil policy, in fact, is the one issue troubling Robbins: "That was the risk in 1990, and it's still around." Nevertheless, he predicts a Dow of 7400 by yearend, and says there's a 1-in-3 chance the Dow will hit 8000.
Still, a few strategists who were among the most bullish in the 1996 survey are getting more nervous in 1997. The jitters started when the Fed took many strategists by surprise with its preemptive rate hike. "We all felt we understood the rules...and that unless we saw the known precursors to inflation such as gold going up or commodities going crazy that the Fed would basically keep policy steady," says Greg A. Smith, chief investment strategist at Prudential Securities Inc. "Then in February and March, [Federal Reserve Chairman] Alan Greenspan started talking about tight labor markets, job uncertainty--a whole new set of issues."
"GOOD GUYS." The equity market has to figure out what the new rules are, says Smith: "Maybe strong growth is bad, and we don't even have to see signs of inflation. If that's true, then what follows strong is weak, and then we have to worry about profits." Still, while the bond market has "nothing to look forward to, the stock market at least has earnings," he says. "Hopefully, we've seen the bad guys--the earnings preannouncements--and now we'll see the good guys" as more earnings reports roll over the wires. Smith thinks a further 0.25% hike by the Fed is already factored into stocks, but he now considers his forecast of 7000 by midyear to be on the high end.
Peter J. Anderson, chief investment officer at American Express Financial Advisors, also strikes a worried tone. "I'm cautious as hell, since our economic framework over the next three to six months is not conducive to an advance in equity prices," he says. Anderson anticipates that three more Fed tightenings will bring the yield on the 30-year Treasury to between 7.25% and 7.75% by the third quarter. "That's not disastrous to common stocks, but it means that equities have to constantly swim upstream," he says. Anderson's target for the Dow at yearend is 6350. But "that is not the end of the bull market," he says. "We'll have another leg. It will just be an interruption."
Just about every strategist acknowledges that the next few weeks will be volatile, as first-quarter earnings reports buffet the market. Indeed, investors will probably have to adjust to living with a lot more volatility in 1997. But for those who have the fortitude to endure the swings, the strategists who called the Dow's rise last year think that enduring the pain will be well worth it.