The Bull May Run--Just Not Too Fast

Analysts expect a modest rally following a grim 2001

Is the stock market's rally from the September lows the beginning of a new bull market or just another bear trap? BusinessWeek's survey of 54 fearless stock market forecasters found that most think the bull is coming back. But don't get too excited. They believe this bull will be less robust than its predecessor, which racked up years of 20%-plus gains.

Indeed, the seers' predictions for 2002 are downright moderate. They are, on average, looking for a 13% rise, to 11,090, for the Dow Jones industrial average; a 15% increase, to 1292, for the Standard & Poor's 500-stock index; and a 14.5% jump, to 2236, for the Nasdaq Composite Index. While impressive after two nasty years, those gains would still leave the indexes from 4.3% to 55.7% below the highs hit in early 2000. "Although 2002 will be a recovery year, it's not going to be nearly as good as a typical recovery year," says Rod Smyth, chief investment strategist at First Union Securities.

True, the economy is getting a potentially powerful kick from aggressive interest-rate and tax cuts and a big fall in energy prices. Yet the forecasters believe recovery will be constrained by rising unemployment and heavy debt loads, which will keep consumer spending in check. Corporations, still working off excesses from boom years, aren't in a position to binge, either.

If the economy is going to rebound modestly, it's unlikely stocks can do much more. Just look at the outlook for corporate profits. Our forecasters think they'll jump 13% in 2002. That's far below the 23% profit rebounds seen in 1983 and 1975, when the economy was also emerging from recession, says Jeffrey Kleintop, chief investment strategist at PNC Advisors in Philadelphia. Moreover, about one-quarter of that gain will result not from improved business conditions but from an accounting change, he says. In 2002, rules no longer require companies to deduct from annual earnings a portion of the goodwill associated with the costs of previous mergers.

The forecasters are more upbeat about the interest-rate prognosis. With many industries swimming in excess capacity, competition remains fierce enough to keep price increases in check--and the Federal Reserve from making an about-face on rates, says Richard Dickson, market analyst at Hilliard Lyons in Louisville.

But if the monetary and fiscal stimuli in the pipeline ignite a stronger-than-expected recovery, all bets on inflation are off. "A year from now, we'll be asking when the Fed is going to raise rates, if they haven't done it already," says Robert Stovall, market strategist at Prudential Financial and one of Wall Street's most vocal bulls (table). Rising rates could dampen the outlook for equities in 2003, Stovall predicts.

The pros' crystal balls did not serve them well in 2001. Last December, most expected the Fed to cut interest rates enough to avert a recession and propel the Dow to 12,015--almost 2000 points above where the index stood when BusinessWeek stopped the clock on its contest on Dec. 7. They missed the Nasdaq by an even wider mark in percentage terms, forecasting a finish of 3583, vs. the actual close of 2021.

Of course, no one could have foreseen the events of September 11. But even if the terrorist attacks had not occurred, the market would have had to rally by 25%--from 9600 on Sept. 10--to turn the gurus' consensus forecast into a reality.

All but one of the 38 strategists polled a year ago overestimated where the Dow, S&P 500, and Nasdaq would be at yearend. Long-time bear George Jacobsen of Trevor Stewart Burton & Jacobsen proved the most prescient when his predictions for all three indexes are combined.

Technology gets the most votes for the sector destined to perform best in 2002. Because tech stocks rise and fall with the economy, "it's a play on a cyclical recovery," says Alvin S. Mirman, director of research at Boca Raton (Fla.) brokerage vFinance and the strategist who is most bullish on the Dow for 2002. "You'll see a stronger rebound than people expect." Even if the recovery is mild, Kleintop argues, companies will spend on technology because items purchased in the late 1990s are already obsolete.

Others caution that tech stocks--which staged a rally late in 2001--have become too expensive again. Unless the economy roars back, says First Union's Smyth, "I don't think you can justify valuations that are on the upper end" of their range. Today, tech stocks trade at a price-to-sales ratio 2.5 times the level of the S&P 500 (minus companies with no sales, including banks). That's close to the sector's historical high of three times the index's multiple, Smyth adds. He champions financial stocks, which, along with health care and tech, round out the strategists' top three sector picks. Those who expect a muted recovery are betting on health care, which delivers steady earnings in good times and bad.

As you would expect in a bear market, most--about two-thirds--of last year's individual stock picks lost money. The biggest dog? Enron, the now-bankrupt energy trader. Still, some forecasters made good calls. Take Allan Roness of ASR Corporate Consultants in Boca Raton. His pick, Trust Co. of New Jersey, gained 95.8%. Let's hope more of the strategists got things right in their forecasts for 2002.

By Anne Tergesen

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