Is This The Year The Gurus Get It Right?
To say that the experts missed the 1997 stock market is like saying Tiger Woods has a future in golf. Before the first month of 1997 was over, the Dow Jones industrial average had blown past the 6587 consensus yearend forecast of the 45 market strategists surveyed in late 1996 by BUSINESS WEEK and racked up the 5% or so average gain expected for the entire year. For 1998, Wall Street's expectations are remarkably similar: On average, with the Dow at 7922 on Dec. 15, the pros' outlooks for the Dow and the Standard & Poor's 500-stock index translate into increases of 5% to 6%, with the Dow reaching 8464 and the S&P rising to 1018.
Even the strategists making the most aggressive calls a year ago, Greg A. Smith of Prudential Securities Inc. and Robert S. Robbins of Robinson-Humphrey Co., fell far short of the Dow's 23% gain and the S&P's 30% rise. Granted, some pros increased their targets during 1997. But a year ago, no one even ventured to think that the Dow could hit 8000. Last year's top guru, Dain Bosworth Inc.'s Robert F. Dickey, was way off base: He predicted a Dow of 4400. For 1998, forecasts range from Dickey's 6100, a 23% drop, to Laszlo Birinyi Jr.'s call for a 10,250 Dow, or a 30% rise from current levels.
MIDYEAR CORRECTION? Earnings worries were on the minds of many market gurus when they formulated their 1997 forecasts, and those worries weigh down their 1998 projections as well. Forecasters expect a year of greater volatility and lower returns. "Slowing top-line growth and increasing cost pressures will lead to profit margin pressures as managements struggle to maintain their high profitability," says Marshall Acuff, chief market strategist for Salomon Smith Barney. Other concerns include troubles from Southeast Asia and Japan spilling over into the domestic market, and rising pressure on wages in the U.S. "Talk of deflation and/or recession will replace talk of irrational exuberance and the inflation watch," predicts Gruntal & Co.'s Joseph Battipaglia. George Jacobsen of Trevor Stewart Burton & Jacobsen Inc., expects just a 4% increase in operating earnings for the S&P 500 as "a fiercely competitive battle for market share unfolds, with Asian and European imports flooding the U.S. and NAFTA partners trying to hold on."
Not everyone expects such strong pressure on earnings. Morgan Stanley, Dean Witter's Peter J. Canelo forecasts an 8.5% increase in operating earnings for the S&P in 1998. "Leading indicators such as the real money supply suggest that earnings will come in above expectations for another year," he says. Don't expect smooth sailing, however: "Interest rates will rise, provoking another midyear correction," he adds.
The two big bulls for 1998 are Laszlo Birinyi Jr. of Birinyi Associates Inc. and Robert J. Froehlich, chief investment officer for Zurich Kemper Investments. Sure, people are worried, says Birinyi. But his computer analysis of the patterns of daily buying and selling shows investors voting for higher prices by buying on weakness. "So much of what I see now I saw a year ago, and a year ago I thought we could go up to 7200, and it turned out I was conservative," he says.
Froehlich also falls into the Dow 10,000 camp. "A strong economy and demographics that encourage savings will push U.S. stock markets to new records," he says. Froehlich expects consumer confidence to stay high due to record low unemployment combined with little or no inflation.
"DEFENSIVE" GROWTH. One of the most unfailingly bullish voices, Goldman, Sachs & Co.'s Abby Joseph Cohen, forecasts the Dow at 8700. While 1997 began with worries that the global economy was "too strong" and could lead to increases in inflation and interest rates, Cohen sees 1998 beginning with worries that the global economy is "too weak" and could lead to fearsome deflation. "Both extreme views will be proved to be wrong," says Cohen, who expects solid domestic growth and a global economy that begins to improve in the second half of 1998.
While the pros are sounding a more cautious tone, their asset allocation is more aggressive. The average allocation to stocks is 65%, compared with 63.7% last year and 61.5% the year before. That includes real estate investment trusts, which are increasingly popular with strategists. The bond allocation moved up to 26% from 24%, and the average allocation to cash is 9%, vs. 12.3% last year.
How did strategists fare choosing individual stocks? As of Dec. 15, Arterial Vascular Engineering Inc., the pick of BankBoston's Edward G. Riley, had risen 374% in price for the year to date. Other winners: Action Performance Cos., up 84%, chosen by Advest Group Inc.'s John H. Shaughnessy, and Eli Lilly & Co., which rose by almost 78% and was Acuff's pick. The worst performers: Silicon Graphics Inc., the choice of Peter J. Anderson of American Express Financial Advisors, and Barrick Gold, Dickey's pick. As of Dec. 15, both stocks had lost more than 40%. The average price gain for the stock picks was about 18%. It shrinks to 10%, though, once Arterial Vascular Engineering's gain is excluded.
This year, the watchword among strategists is "defensive" growth. Financial companies are the favored sector because of continuing consolidation and support from what some see as a stable-to-lower interest-rate environment. Drug and biotech companies also are favorites. "It's easier to sell sodas, razors, and drugs than it is to sell cars, tractors, and airplanes in a global economy threatened by deflationary dominoes and a global goods glut," says Rob Brown of Ferris, Baker Watts Inc. But Brown's favorite stock is a small-cap company, Patina Oil & Gas. "It has a proven track record to grow reserves, production, and cash flow through acquisitions, and follow-on development drilling," he says.
Technology remains a favorite. Canelo figures there will be tremendous exports of U.S. technology as Europe substitutes technology for labor. "Labor is just too expensive," he says. "Technology is the only way they can stay competitive." Canelo's favorite stock, however, is another energy play, Vintage Petroleum Inc. "Global demand for energy will resurge in 1998," he says.
The New Year begins in an uncertain and volatile investment environment. "By yearend, a lot of investors will be grousing about single-digit or negative returns," says Key Asset Management Inc.'s Charles G. Crane. While caution hasn't rewarded strategists in the past few years, it may pay off in 1998.