Ready For Dow 9000?

The Groundhog Day leap may signal a big new surge

Feb. 2 could mark the birth of a new market phenomenon: The Groundhog Effect. With Staten Island Chuck predicting an early spring, the Dow Jones industrial average surged more than 200 points, to 8107.8, racking up its fourth-largest point gain ever, and the Standard & Poor's 500-stock index charged through 1000 for the first time.

Heartened by positive news out of Asia, the end of a much-feared earnings season, and the simmering down of Zippergate, investors breathed a sigh of relief, sending stocks soaring. But while the relief rally may bring the Dow above its August, 1997, high of 8259.3, market mavens are sharply divided over the staying power of this latest move.

Peter J. Canelo, an investment strategist at Morgan Stanley, Dean Witter, Discover & Co., thinks the market can move much higher in 1998. "The market is slowly gaining confidence that the U.S. is pretty isolated from Asia," he says. On Feb. 3, he and his colleague, chief U.S. investment strategist Byron R. Wien, advised clients to move money from cash into equities.

ALTERED PSYCHOLOGY. Canelo thinks that after a weak first quarter, earnings could prove a lot stronger than many people think. He sees better-than-expected operating leverage, lower interest expenses that have been locked in, and continuing productivity gains. He expects the decline in oil prices to help keep inflation down and lower interest rates to offset the hit from reduced trade with Asia. By yearend, the Dow could be at 8600-8700--perhaps even 9000, he says.

Goldman, Sachs & Co.'s Abby Joseph Cohen thinks the Dow will "easily achieve" 8700 by yearend. She likens the U.S. economy to a supertanker whose course cannot be easily altered and which "can navigate fairly rough seas." Cohen expects the aggregate impact of Asia to be a "moderate negative" in the first quarter but believes corporate profits will stay relatively strong, and inflation benign.

Even analysts who aren't as bullish as Canelo and Cohen concede that investor psychology has changed dramatically. What they question is whether the euphoria will be supported by stronger fundamentals. "Psychology drives the market in the short run, but fundamentals drive it in the long run," says Charles G. Crane of Key Asset Management Inc. He argues that the fundamentals haven't improved over the past few months and that "meager top-line growth will gang up with rising employment costs" to hurt corporate profit margins.

While there appears to be some positive news out of Asia, Greg A. Smith, chief investment strategist at Prudential Securities Inc., still thinks that earnings at many companies will be adversely affected. Moreover, while investor psychology has improved, he says profit expectations are overblown. Smith sees 1998 as a year of high volatility and negligible stock returns.

Nowhere is the change in psychology more apparent than in the rush to buy technology stocks. Market bulls believe tech stocks will provide the market with leadership. "Software and computer companies have been largely unaffected," says Canelo. He thinks tech is the key area for bargain hunters.

The outlook for Asia and its impact on U.S. earnings--especially for some tech companies--is far from clear. The market will swing violently as events unfold in Asia. But this latest rally shows that the 15-year bull market is alive and kicking.

    Before it's here, it's on the Bloomberg Terminal. LEARN MORE