Street strategists say rate hikes will cool, not kill, boom
times
By LAUREN R. RUBLIN
Oh, the hand-wringing! Oh, the hand-holding. If these are trying times for
investors, they're arguably doubly trying for the Wall Street strategists
portfolio pros look to for advice and solace when the market's seas turn
choppy. To the brokerage-firm gurus-in-chief falls the challenge of explaining
the twists and turns of the Dow; deciphering the Delphic pronouncements of
the chairman of the Federal Reserve, and affording a shoulder to kvetch on
when the first two are impossible. No wonder most of the seers we rang up
last week phoned back from airports, hotels and taxis, having been sent
'round the globe to spread the good word about stocks ("The sky isn't falling,
although your returns are") in a jittery market.
So, what do these crystal-ball gazers foresee for the stock market now? For
the most part, the Street's leading strategists remain sanguine about the
prospects for stocks in the second half of the year, despite the Federal
Reserve's dogged determination to slow the sizzling U.S. economy through
repeated interest-rate increases. The approach hasn't worked yet, after six
such hikes, and there's near-unanimous agreement among market watchers
that more rate boosts are in the offing. But the strategists largely believe the
Fed's bitter pill, deftly prescribed, merely will cool, not kill, the boom times
that a grateful citizenry has come to know, love and depend upon for the past
five years.
That's not to say the Dow
Jones Industrials and other
market measures will reprise
the hefty double-digit gains
they posted in each of these
years. Indeed, several folks
with whom we spoke expect
the technology-laden Nasdaq
Composite, which soared a
mind-boggling 86% in 1999,
to end this year deeply in the
red. Still, even if the Dow
climbs "only" 8%-10%, that
will represent an impressive achievement for a benchmark that is about 7.5%
underwater year-to-date.
As '99 drew to a smashing close -- the Dow rallied 25.2% to 11,497, and the
S&P 500 19.5% to 1470, on the year -- most Street sages maintained the
market would revert to more normal growth of around 10% in 2000. Abby
Joseph Cohen, Goldman Sachs's chief market-minder, cautioned clients for
the first time in years that the market was at "roughly fair value," and in March
she actually lowered the firm's recommended equity weighting to a "normal"
65% from 70%, an overweight position. In a fishbowl where small changes
can mean big things, the move was interpreted as a notable expression of
caution from one of the bull market's staunchest supporters.
Still, Cohen and others sounded downright upbeat compared with J.P.
Morgan's Douglas Cliggott, who pegged the Dow at 10,000 by the middle of
this year and warned that 2000 would be about "correcting the excesses" of
'99. Nor does Cliggott see any reason to change his mind or his forecast and
join the ranks of the tepid optimists now. Not only has the Fed constrained
the money supply, he says, but the dampening effects of tighter liquidity have
been compounded by three new developments -- accelerating inflation, higher
interest rates and a likely economic slowdown -- in addition to that old
standby, rich stock valuations. "We don't know how hard the landing will be"
for the economy or the markets, Cliggott says. "But the Nasdaq at 3500, the
Dow at 10,500 and the S&P at 1400 are not priced for a world with a lot of
uncertainty."
Consider the irony, if not the absurdity. A year ago, he notes, the Nasdaq
was trading a thousand points lower, and "conditions were idyllic."
So far, the biggest surprise of 2000 hasn't been the slumping stock market,
but the blistering strength in the U.S. economy. "Everywhere you look -- in
final sales, consumer spending, housing activity -- there are no signs of
slowdown," Prudential's Greg Smith observes. To some degree this
robustness may owe to seasonal factors, including bonus payments and tax
refunds. But incipient pricing pressures should be evident to anyone who
drives a car, heats a house, or pays a monthly health-care insurance premium.
Consequently, the Federal Reserve stands front and center in charting the
destiny of the financial markets for the first time in several years. "Your market
call this year is really your Fed call," Lehman's Jeffrey Applegate says. So far,
the Fed has hiked the federal-funds rate six times since last fall, most recently,
last Tuesday, by a half-percentage-point to 6.50%. Applegate believes
Greenspan and his fellow inflation-slayers won't lay down their arms until late
August, after having tightened by another three-fourths-point. In the near
term, he adds, the market could head lower, as investors confront the
one-two punch of slower growth and higher rates.
History teaches, however, that stocks start to
rally, on average, about six weeks before the last
in a series of rate hikes. "If the data begin to show that consumer spending is
slowing, the market will reprice for the Fed to go on hold," Applegate
predicts. "That means we've got a rally coming this summer."
Tom Galvin of Donaldson Lufkin & Jenrette heartily concurs. "The Fed is in
the eighth inning," he boldly asserts, comparing the current period to the
"inflection point" between the sixth and seventh rate hikes in 1994-95. "Back
then stocks rallied 25%-30% after the sixth tightening, which to me is a good
nine- to 12-month view," Galvin says. That means the Dow could be sailing
comfortably above 13,000 by this very date next year.
If the market's recent tumult has reminded investors of who's really in charge,
the vicious downdrafts and whiplash volatility of the past few months, not to
mention the comeuppance of hedge-fund legends such as Julian Robertson
and George Soros, also have rejiggered some newfangled notions of risk.
Don't expect the volatility to abate much either, our informal survey suggests.
"Volatility is the cost of the Information Age," PaineWebber's Edward
Kerschner avers.
Just how much has the market been swooping and soaring lately? According
to Goldman's equity-derivatives research team, the three-month volatility of
the S&P 500 is 28.2%, meaning there's a 66% chance that the market will
swing up or down by that amount within the next 12 months. At the beginning
of this year, similar volatility measures stood at a more subdued 18.9%.
Average stock volatilities are almost twice as high as the index right now,
particularly in the technology sector, where good and bad news alike have
prompted passionate investment responses. Whether this year's frequent
selloffs have purged most, or just some, of the tech-stock excesses is open to
hot debate. What isn't is the fact that such outbreaks of sobriety are healthy.
"The market rightly is falling out of love with companies that have promises,
not earnings," Kerschner says.
Abby Cohen puts it another way. "The market is having an attitude
adjustment!" she declares gleefully. "Investors have stepped back and asked,
'What were we thinking?' "
What "we" are thinking now, it seems, is that an altitude adjustment might also
be in order. That's the consequence, at least, of investors' dawning realization
that there may be more investment merit in the 40% of S&P 500 stocks
languishing at 12 times earnings or less than in certain Nasdaq names
(withheld to protect the guilty) still changing hands at nosebleed multiples of
sales. In practical terms, says Salomon Smith Barney's Marshall Acuff, such a
"rebalancing of the market's internals" could spell a new low in the Nasdaq
long before summer's end, although not necessarily lows in the S&P or the
Dow. Doug Cliggott, for one, thinks the Nasdaq could do a "slow bleed" to
the neighborhood of 2400-2600, about 25% below current levels.
While no one's counting tech stocks out, investors have been shifting what's
left of their attention to more defensive names and less expensive issues.
Richard Bernstein, chief of technical research at Merrill Lynch, believes the
new market leaders will be "an odd combination of late-cycle stocks" --
energy and basic-industry issues, followed closely by consumer staples. As
the Nasdaq topples, he adds, real-estate investment trusts and utilities also
will do better.
In fact, a quick scan of the daily papers reveals the shocking truth: The S&P
Utilities Index is leading the market this year, with a gain of 19%, with the
Dow Utilities not far behind. REITs, notes Bear Stearns strategist Liz
Mackay, are up about 5%; add in another seven percentage points of yield,
and they look darned near irresistible in this Scrooge-like climate. If nothing
else, she says, the fact that REIT stocks are showing up on the market's
new-highs lists points to investors' newfound risk aversion.
Many strategists these days are pounding the table for energy shares, in light
of rising prices for oil and natural gas. "We figure, let's be part of the
problem," says Greg Smith, of Prudential. "We like gas stocks such as
Coastal and EOG, and drillers such as Baker Hughes and Nabors Industries."
Smith is also a fan of WellPoint and United Healthcare, two HMOs, as well
as semiconductor-makers Cypress and Texas Instruments. "We don't want to
invest in companies that might be hurt by rising costs, but in those responsible
for the cost pressures," he says.
If one idea falls by the wayside this year, along with a great many hapless
stocks, it is likely to be the notion that Old Economy and New Economy
companies are a breed apart. Rather, smart investors have begun to
appreciate technology's transforming influence in so-called Old Economy
outfits. "It's not going to be Old Economy versus New Economy, but the real
economy and real cash flow," says Bear Stearns' Mackay. "We're looking at
old companies, such as United Technologies and Gap, that will see big
improvements from new technologies, including the Internet." Gap, she notes,
has reported that 40% of its online shoppers are new customers.
As the market wilted yet again Friday -- the Dow and Nasdaq each declined
about 150 points -- it was tough to imagine a rally down the road, much less
one with sufficient vim and vigor to send stocks to new peaks. This year's
rosy outlook for corporate earnings certainly strengthens the bulls' case,
although, as Morgan Stanley Dean Witter's chief U.S. investment strategist,
Byron Wien, points out, S&P 500 profits will grow at a decelerating rate in
the remaining three quarters of 2000. Next year, moreover, preliminary
earnings estimates call for even slower growth, as many industry sectors face
difficult comparisons with this year's muscular results.
If most strategists cling to the view -- and the hope -- that the Dow will end
the year higher, how do their clients feel? "A directionless, volatile market puts
everyone in a lousy mood," says PaineWebber's Kerschner.
Small consolation this, but the killjoys at the Fed probably aren't having much
fun either. "The Fed needs to take the steam out of the economy in order to
relax and enjoy the summer months," DLJ's Galvin offers. Investors need to
get the Fed out of the picture quickly, in order to do the same. |
