business

Scrooge Is Haunting Wall Street

Analysts' moods are darkening as the long-awaited pickup in the economy and stocks gets pushed back to 2003's second half

By Amy Tsao

Wall Street is short on holiday cheer, and it may not be thinking happy thoughts for a while yet. With the threat of a war with Iraq still looming, capital spending lackluster, and consumers staggering under the burden of holding up the economy, the markets have plenty to be nervous about. "All the evidence tells me that momentum isn't turning positive in any meaningful way," laments Trip Jones, senior vice-president of Fulcrum Global Partners, a New York-based independent research and brokerage firm. "I spend all day trying to find good stuff, but I can't."

Jones's bah-humbug mood isn't unusual at the moment. Though many analysts are predicting a better year for stocks in 2003 -- a 14% rise in the Dow is a common guess -- the lingering problems from 2002 could inhibit the formation of a lasting advance in the early months. Thus, for all but the most adventuresome investors, it may be best to wait and see for a bit until the market's direction is clear. Even the seasonal rally known as the "January effect" may be subverted by war talk, says Jeffrey Kleintop, chief investment officer at PNC Advisors in Philadelphia.

D-Day, so the speak, may be Jan. 27, when the U.N. weapons-inspection team makes its first substantive report on whether Iraq has been stockpiling weapons of mass destruction -- one day before President Bush makes clear his true intentions in his annual State of the Union address. Until then, daily headlines -- of a U.S. troop buildup, of other countries arming, of spiking oil prices -- will shape Wall Street's mood. "I see choppiness and an event-driven market for the next three months," says Chris Jarvis, associate director of private-client research at financial-advisory company Advest in Hartford, Conn.

ALL THE TRIMMINGS.

  Many experts think a conflict with Iraq would be quick -- much like the Gulf War in 1991. If that turns out to be the case, stocks should tick up in the wake of a U.S. victory. Any rally could be short-lived, however. "We're trying to rein people in," Jarvis says. "When you look at the last recovery [1991 to 1992], we were on the verge of explosive growth. This time, there will be drags."

Specifically, he cites the slow pace of recovery in business spending and weakening consumer spending as factors that would moderate a post-Iraq market expansion. And if by some chance victory weren't swift and sure, or if the war expanded to include North Korea, the effect on the markets could be devastating indeed.

For now, Wall Street is more concerned about the short term, which means fourth-quarter profits, for which many companies will provide guidance in early January. Negative surprises should outnumber positive ones from companies in the S&P 500 index, predicts earnings-tracker First Call. During the first half of 2002, the number of companies that raised guidance rose steadily, but lately the trend has faded. In the third quarter, some 43% of warnings were negative and 26% were positive, with the remainder neutral.

STILL WAITING.

  Already, in fact, many analysts are pinning their earnings expectations for 2003 on the latter half of the year. That echoes a refrain that became common in 2002: Things will get better -- just you wait. "We hate to keep being the bearer of bad tidings, but the outlook for the first half of 2003 has been cut to the point that it looks like two more quarters of lackluster growth," says Chuck Hill, First Call's director of research.

Since October, analysts have dropped their earnings growth estimates for the first quarter from 17% to 12%, and for the second quarter from 16% to 12%. Not bad in an environment where both interest rates and inflation are at rock-bottom levels, but Hill expects analysts to keep trimming their predictions.

Also, after a 15% rise since October, stocks aren't cheap on a price-to-earnings basis, using projected earnings for 2003. The S&P 500-stock index is trading at about 23 times next year's anticipated earnings, vs. a more normal range by historical standards of between 11 and 20 seen before the 1990s boom. Carlos Asilis, U.S. equities strategist at J.P. Morgan, predicts that the S&P 500 should finish around 800 at the end of 2003, vs. the current 895. While the consensus earnings expectation for the S&P 500 is $39.52 per share in 2003, Asilis is forecasting EPS closer to $34, nearly 14% below the consensus and above the consensus projection of $31.69 for 2002.

LACKING THE MEANS.

  Significantly, the rock that sustained the economy over the past two years -- the consumer -- is beginning to show signs of wear. Debt levels are at record highs, and the unemployment rate, now at 6%, could continue to inch up. Reports from retailers on their holiday shopping seasons will also likely point to a flagging consumer. And auto makers' end-of-year results could foreshadow the start of a major slowdown in demand. "Consumers will be sluggish at best. They may have the will to buy, but not the means," Jarvis says.

Signs of improved corporate spending also will continue to be sparse in the early part of the year. In December, Intel (INTC ) Chairman Andy Grove said it's too early to forecast a rebound in chips, typically a leading indicator of a recovery in tech spending. "Companies are spending, but very methodically," says Jarvis. Most analysts expect corporate spending to pick up gradually, but probably not until the second half of 2003.

A lot of things could also go right, of course. During the first quarter, President Bush could find a way to corral Saddam Hussein without starting a shooting war. He could also jump-start the economy with a stimulus plan built around tax cuts and investment incentives. Bulls also note that professional money managers will have few attractive choices other than U.S. stocks, as returns on bonds remain relatively unappealing and the outlook for global investing stays murky. And some of Wall Street's reforms might also lift spirits -- and even confidence in the veracity of corporate chieftains.

For now, however, investors don't need to be in a rush. At best, the early part of the year will be bumpy. If, indeed, 2003 sees a breakout for stocks, you'll have plenty of time to jump in.

Tsao covers the markets for BusinessWeek Online in New York

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