The Bull in the Crystal Ball

Strategists and portfolio managers see a Dow rally in '03. But then, they saw one in '02, too.

Oh, well.... For the third straight year, the stock-market forecasters surveyed by BusinessWeek vastly underestimated the bear market's severity. While they projected on average that the Dow Jones industrials would end the year at 11,090, the index stood at 8646 on Dec. 6, when the contest ended. Even Bernie Schaeffer, the seer most on target, overestimated the Dow by 4% (page 108).

Will the forecasters, who work as investment strategists or portfolio managers, fare better in 2003? The last three years haven't dampened their enthusiasm. Their outlook for 2003 is even more bullish than a year ago. The 67 prognosticators, who responded to our annual questionnaire, show an average 17% rise in the Dow by yearend to 9871, an 18% boost in the Standard & Poor's 500-stock index to 1049, and a 25% leap in the NASDAQ Composite Index to 1703. These expectations may turn out to be tame if the bear goes back into hibernation: The last great bear market ended in 1974, and the Dow rose 39% and the S&P, 31.5%, in 1975.

There are some big differences between this bear market and the one in the '70s. Then, the U.S. had high inflation and stocks had low price-to-earnings ratios. Now we have low inflation and high p-e ratios. So if stocks are to soar, earnings need to stage a big comeback. "The key is profit-margin expansion," says Jeffrey Kleintop, chief investment strategist of PNC Advisors. That will happen, he says, as companies use increased productivity to contain labor costs. He forecasts 12% profit growth on a 6% increase in sales.

Kleintop's prediction is right in line with the average forecaster, who expects a 12.3% earnings gain. But within that average is wide variation, from as little as 3% to a plump 40%. James Paulsen, chief investment officer at Wells Capital Management, projected the biggest gain because of the economic policy stimulus of lower interest rates and increased fiscal spending. By contrast, Richard Pell, CIO of Julius Baer Investment Management Inc., who sees only a 5% increase, thinks profits will be held back by the costs of funding pension plans drained by the bear market.


Despite their disparate outlooks, most forecasters strongly favor stocks over bonds. The average prognosticator recommends allocating 68% of your portfolio to stocks and 23% to bonds, with the remainder going to cash and alternatives such as gold, real estate, and hedge funds. "I think we have seen the low in interest rates," says Peter Trapp, portfolio manager of Needham Growth Fund. Since bond prices fall when rates rise, Trapp thinks bonds will lag. His fund, which has put as much as 25% of its assets in bonds and cash during the bear market, is now almost 100% in stocks.

Just because the prospects for bonds look bad doesn't mean stocks are a fat pitch. "During the 1990s there were tremendous forces that came together to drive stocks up that are not likely to reappear for quite some time," says Laszlo Birinyi Jr., a stock strategist for Deutsche Bank Securities Inc. The decade started with high interest rates and a weak dollar. As rates fell and the dollar strengthened, it was a boon to the U.S. markets. It was also a relatively peaceful time, so the government could focus on domestic issues, says Birinyi. "We're not blessed with that today."


Without powerful macro forces behind the stock market, strategists stress stock selection, and health-care stocks are among seers' top picks. Drug titan Pfizer (PFE ) was the most popular health-care stock. Carlos Asilis of J.P. Morgan Chase & Co. cited Pfizer's "defensive characteristics, robust earnings growth outlook, and attractive valuation."

Technology and financial services were the second and third favorite sectors. "If it's going to be a good stock market in 2003, the sector that was beat up the most will come back the most," says Hugh A. Johnson Jr., CIO of First Albany Cos. "That sector is technology." Johnson is buying Cisco Systems (CSCO ), which he says is sitting on $20 billion in cash and is reasonably valued. "You want to pick something in the tech space that is going to be around at the end of 2003," he says. "This company is not going out of business." Another pick: Microsoft (MSFT ), which independent strategist Jeffrey M. Applegate says is valued at the low end of its historical p-e range.

Many strategists think banks will do well as credit quality improves during a recovery, and they can speed their lending. For this reason, Citigroup (C ) seems cheap to many, despite concerns about litigation woes with subsidiary Salomon Smith Barney. Merrill Lynch & Co. (MER ) also cropped up as a company that has trimmed costs through staff cuts and business reorganizations.

Consumer staples stocks are the least popular. One-third of the strategists agree that steady food, beverage, and tobacco stocks aren't cheap and often trail other sectors in a bull market. Utilities and retailers also are out of favor.

Although they haven't had a great track record in recent years, 2003 could be the year the necks of the Fearless Forecasters are spared.

By Lewis Braham

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