Bulls in Denial

Even their cyclical darlings are losing steam

A storm of disappointment is hitting Wall Street. On Apr. 4--a date widely regarded by strategists as a bottom--the stock market embarked on a hoped-for recovery. A sorry first quarter behind it and three interest-rates cuts still ahead, prospects looked good: By June 7, the Nasdaq composite index had soared 38%, and the Dow Jones industrial average and the Standard & Poor's 500-stock index had both leaped by about 16%--wiping out almost all of the year's losses.

Then, day by day, the market began to lose its nerve. In just one month, it has lost almost half of the advances made from its April low. The market seems to be second-guessing itself: Are swelling layoffs and unemployment rates taking their toll? Will they push the economy into a recession? Why haven't low inflation and favorable interest rates jump-started the economy? Is monetary policy broken?

NO "ABYSS." The bulls--and they're all over Wall Street--are resolute about a recovery. They say low inflation and falling rates means good times by yearend. They believe consumers will keep the faith. A poll of 56 equity firms by International Strategy & Investment Group, in fact, found that six-month outlooks are more upbeat than they have been since 1994. Says Goldman, Sachs & Co.'s chief U.S. strategist, Abby Joseph Cohen, many stocks have already reached their lows in the "unsustainably bad" first half. "We think the markets will be moving higher," she said at a July 10 analysts meeting. "We don't think we're on the edge of an economic abyss."

However, the bulls may be in denial. They seem to be suffering from the same overconfidence that has struck their Wall Street cousins--analysts who forecast earnings. Analysts have failed to accurately forecast how the slowdown has hit the bottom line (table), and earnings estimates for 2001 for the overall market and the tech sector continue to be slashed. Moreover, since February, both the S&P 500 and the Nasdaq composite index have traded below their 40-month moving averages. The last time both indexes traded that low was in 1982 and 1990, respectively. Says Research Manager Joseph W. Sunderman, at Schaffer's Investment Research: "When there's a break below this average, it's better not to gamble on a up leg in the market."

Even consumers' resiliency is cracking. According to the Conference Board's most recent report, people are starting to cut back on such big-ticket purchases as homes, cars, and appliances. "We're teetering on the brink of a recession," says money manager Guy R. Elliffe. "Nevertheless, the market has lived the recovery without ever having gone through the downturn."

Elliffe's views shouldn't be taken lightly. He's one in a three-man investment team at Oakland's (Calif.) Jurika & Voyles--ranked No. 1 in BusinessWeek's survey of 40 investment strategists who, in December, 1999, pegged where the markets would be a year later. Few at that time bet that the Nasdaq--then at a new high of 4,000 and headed higher--would retreat to 3,000, a slim 83 points off Elliffe's target. The firm's calls on the Dow and the S&P 500 were a negligible 2% off the mark. Eighteen months later, Jurika & Voyles is still bucking Wall Street wisdom: Elliffe and colleagues forecasts the Dow will close at 9250 and the Nasdaq at 1800 by yearend.

TOO DEAR. The bulls-and-bears battle today is not over New Economy stocks, but over old-fashioned cyclicals--where upbeat strategists say to put your money. Cyclical stocks--like consumer goods and basic materials--are usually the first to zoom in recoveries: "It's the start of a brand-new market cycle," says USB Piper Jaffray market strategist Brian G. Belski, who favors International Paper and Alcoa. Prudential Securities' director of technical analysis, Ralph J. Acampora, likes, among others, Caterpillar and Georgia-Pacific. "It's a huge mistake to turn your back on cyclicals," he says. "It's a stealth bull market."

Stocks like Caterpillar, Goodyear Tire, Alcoa, and Target had jumped 50% to 90% from their lows last year to reach 52-week highs in May, when the market thought the economic recovery was in the bag. But deteriorating profits have eaten away at those recent gains. Says Director of Research Charles L. Hill at Thomson Financial/First Call, downward revisions aren't over yet. "If you believe this is a real downturn, there's still plenty of room to go."

Even assuming a best-case scenario, says Elliffe, many of Wall Street's current darlings are too rich for would-be buyers. Take 3M, lauded by Edward Kerschner, chief global strategist at UBS Warburg. At 112, the stock trades at 24 times estimated 2001 profits--steep for a company where earnings grow in the mid-single digits, says Elliffe. Caterpillar's projected 2001 earnings are down 13% from last year, yet the stock is up 70% since a low of 29 last September. Consumer stocks, such as Home Depot and Costco are pricey, too, he says. Williams-Sonoma Inc.'s 2001 estimated earnings were revised down to $1.21 a share from $1.77 this year; the stock is still up 10% since December.

If the bulls are still off the mark, like they have been for more than a year, then the market could get worse before its gets better. And maybe then the cyclicals will point the way.

By Mara Der Hovanesian in New York

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