Plain sailing may not lie ahead
By Alan Deans, New York
Now that Alan Greenspan has taken the uncertainty
about interest rate increases out of US financial markets,
plenty of investors seem happy. Long bonds dipped last
week back below 6 per cent, and the Dow Jones
Industrial Average closed at 10,855.6 points to gain 3.5
per cent for the week. The Nasdaq market piled on a
heady 4.7 per cent.
Everything seems to be back in its place. Or is it?
The proponents for a northern summer rally in stocks
point to rosy earnings-growth expectations to justify
further gains on Wall Street - already up 18.2 per cent
for the year, more than for all of 1998. The cautious point
to the chance of more than one rate rise this year, bond
yields remaining around current levels and selected
sectors of the market continuing to do badly.
A consensus view might say, therefore, that while the
weather is conducive, plain sailing might not lie ahead.
Goldman Sachs's Neil Williams says that bond yields are
unlikely to rise further given the outlook that inflation
remains under control. "The valuation threat to stocks
from rising interest rates should abate," he says. But he
notes stocks have gained so much since the northern
autumn slump that he recommends a bias towards bonds.
Plenty of fund managers have been buying bonds lately,
taking the surge through 6 per cent as the key to indicate
that that was where fair value lay. But will they continue
to buy now that yields have slipped quickly?
Morgan Stanley Dean Witter's Peter Canelo says bonds
have simply returned to a more appropriate trading
range, one that prevailed before last year's debt and
hedge fund crises erupted. "Of course, bond yields could
go higher if we are facing an open-ended acceleration in
the rate of inflation." But Mr Canelo does not believe
pricing is about to get out of hand. Supporting his view,
he cites a strong US dollar, low rates of capacity
utilisation, moderate wage growth, strong productivity
and low industrial commodity prices.
But Mr Canelo does note that "the ability of an
overvalued stockmarket to withstand increases in long
and short-term interest rates ultimately rests upon the
strength and direction of earnings growth". Here, there
continues to be bright prospects.
Boston research group First Call says that the 10.5 per
cent profit growth shown by S&P 500 companies in the
first quarter should be followed by around 15 per cent in
the second quarter. "Leading the way again will be
technology," according to director of research Chuck
Hill. "Although technology sector estimates have been
reduced somewhat over recent months, the outlook is for
growth of 39 per cent, almost as much as the 42 per cent
in [the first quarter]." Leading technical analyst Ralph
Acampora, of Prudential Securities, does not believe the
way is yet clear for smooth waters. "Is the correction
over? My answer is no!"
He says the market is not oversold enough to suggest that
the worst is behind investors, adding that sentiment is still
too optimistic and that trading volumes have been too
light. Mr Acampora's suggestion is for people to
overweight cyclical stocks as he believes they are "on the
verge of a multi-year race to outperform the market".
And what of the recently high-flying internet sector?
Liquidity Trim Tabs's Charles Biderman notes that many
individual traders are being wiped out by margin calls. He
says that while leaders such as America Online, Schwab,
Yahoo!, amazon and Priceline have fallen by about 50
per cent from their peaks, this might be only the start of
the end game. He believes internet stocks could drop at
least another 50 per cent from these levels.
afr.com.au
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