Cry a little ;0/
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The Bulls Have It!
By KOPIN TAN
TO CALL THIS SUMMER A NERVOUS one for investors is to traffic in understatement. The stock market suffered its first correction in 4½ years when the Standard & Poor's 500 skidded 12% recently. The Dow Jones Industrial Average makes triple-digit jumps or slides -- often within a single day. The mood swings come fast and furious as mortgage defaults rise, lending conditions tighten and traders grapple with the impact on the economy. And that's all before September, traditionally a volatile month for stocks.
So it might be reassuring to some -- and surprising to others -- to hear how Wall Street's top strategists calmly expect stocks to finish the year higher. In fact, the eight strategists surveyed by Barron's see stocks climbing well into 2008, despite the credit-market tumult and the policy uncertainty of the election year.
The average forecast among the eight calls for the S&P 500 to reach 1568 by New Year's Eve, or 6.4% higher than today's level of 1474, and even the most cautious have penciled in hardly any downside for stocks. In contrast, their economic prognosis is far less assured and unanimous: Three firms see economic threats grave enough to require the Federal Reserve to slash interest rates to 4.5%, from 5.25% today, while two others think the economy is doing just fine.
The strategists' bullish tilt is especially remarkable considering how many believe the financial markets have altered for good, with the days of easy money and cheap debt fading like the summer heat. "We've been through a long period of extraordinarily easy credit, and there's no putting that genie back into that bottle," says Tom McManus, Banc of America Securities' chief investment strategist.
Instead, what lies ahead is "a multiyear period of credit rationalization, reduced leverage and less speculation, and a shift toward more fundamental investing," says Merrill Lynch chief investment strategist Richard Bernstein. "We're not going back to how things were -- not even if the Fed cuts rates and floods the market with money."
Larry Adam
Deutsche Bank
S&P 500
Year End:1550
12 Months: 1650
10-yr Treasury Yield: 5.0%
Fed-Funds Rate: 5.0%
S&P 500 Op Profits '07E: $96
'08E: $107
Favored Sectors: Info tech, health care, industrials, energySo what drives their sanguine stock outlook? The strategists expect U.S. profit growth to accelerate, driven by the engine of a global economic boom. All are counting on interest rates staying meekly cooperative.
Over the past few years, strategists have generally been bullish in Barron's twice-yearly surveys -- and they have mostly been right. The jury is still out for this year. Last December, the group had called for an average 8% gain for 2007, and the S&P 500 had rallied 9.5% to a record 1553 mid-July. But after falling quickly to 1371 by mid-August, it is up just 3.9% for the year.
Richard Bernstein
Merrill Lynch
S&P 500
Year End:1530
12 Months: 1560
10-yr Treasury Yield: 4.25%
Fed-Funds Rate: 4.5%
S&P 500 Op Profits '07E: $93
'08E: $92
Favored Sectors: Health care, consumer staples, telecom, industrialIn the latest survey, performed in mid- and late-August, one of the most bullish strategists was François Trahan, chief investment strategist at the broker-dealer and investment advisory firm ISI Group. He thinks the economy is in the throes of a mid-cycle slowdown brought on by 17 interest-rate hikes -- but he doesn't see the economy weakening enough to trigger any immediate rate cuts.
"People also equate the credit crunch with a liquidity crunch, and that's wrong," Trahan says. Among other things, cash on corporate balance sheets is high, at nearly 15% of the stock market's total valuation, and the influx of petro-dollars and global money-supply growth all make for abundant liquidity. Trahan stands by his year-end S&P 500 target of 1700, which he set this spring, and he favors cyclical sectors like materials, industrials and technology. He shuns rate-sensitive financial stocks and counter-cyclical sectors like utilities and consumer staples.
David Bianco
UBS
S&P 500
Year End: 1600
12 Months: 1650
10-yr Treasury Yield: 4.5%
Fed-Funds Rate: 4.75%
S&P 500 Op Profits '07E: $95
'08E: $101
Favored Sectors: Industrial, energy, technological, financialsAUGUST'S JITTERY STOCK slide also was seen as a contrarian Buy signal. "Investors are very nervous right now, and embedded risk premium is higher than warranted," says Goldman Sachs' Abby Joseph Cohen. "The stock market is undervalued relative to its fundamentals." In addition, corporations' balance sheets are in "excellent shape," with enough liquidity to finance new jobs, strategic acquisitions and business expansion.
Downside stock risk is further limited by stocks' moderate valuation, the strategists say. The S&P 500 is trading at 15.9 times its operating earnings over the past four quarters -- within the valuation "bull's eye" of between 14 and 16 times, notes Citigroup's Tobias Levkovich. Since 1940, a price-to-earnings in that range has produced strong returns averaging 17% in the next 12 months.
Abby Joseph Cohen
Goldman Sachs
S&P 500
Year End: 1600
12 Months: 1680
10-yr Treasury Yield: 4.75%
Fed-Funds Rate: 4.5%
S&P 500 Op Profits '07E: $93
'08E: $100
Favored Sectors: Energy, info tech, industrialRobert Parker, a London-based senior member of Credit Suisse's global investment committee, sees U.S. economic growth slowing to about 2% in the second half. But large U.S. companies' exposure to robust European and Asian growth, along with a weak dollar, will stave off a U.S. recession. As the debt market backs off, the "mountains of LBO cash that had been raised will increasingly be used to take large minority positions" in public companies, with private equity looking to boost returns through operational restructuring or management change -- as opposed to financial leverage.
Will defaults spread quickly from subprime through the credit spectrum? How will stricter lending affect Americans' relentless spending? Will companies keep hiring if consumer spending slows? As long as questions like these persist, Larry Adam, Deutsche Bank Alex. Brown's chief investment strategist, will favor stocks hitched to business spending over those dependent on consumers. He is also steering toward companies with foreign sales, strong pricing power and reduced sensitivity to interest-rate movement.
Tobias Levkovich
Citigroup
S&P 500
Year End: 1600
12 Months: 1725
10-yr Treasury Yield: 4.90%
Fed-Funds Rate: 4.5%
S&P 500 Op Profits '07E: $94.75
'08E: $101.75
Favored Sectors: Info tech, energyMerrill's Bernstein has a short list of five investment themes. He believes, for instance, that better value can now be found in developed markets than in emerging ones, which have attracted hordes of investors that have fully priced in the growth potential. Risk-averse investors also should be guided by dividends and cash holdings, he says. Other areas to focus on in this volatile market include high-quality bonds, large-cap stocks and defensive sectors.
In fact, large-cap stocks and foreign sales exposure have become such recurring themes one might question the wisdom of such popular ideas.
"Yes, some of these trades may be crowded," says Goldman's Cohen of the preference for large-cap stocks and global exposure. "But it's still worthwhile if its price-to-earnings or price-to-book valuations are still attractive. The consensus is not always wrong."
Tom McManus
BofA Securities
S&P 500
Year End: 1465
12 Months: 1590
10-yr Treasury Yield: 5.10%
Fed-Funds Rate: 5.0%
S&P 500 Op Profits '07E: $93
'08E: $102
Favored Sectors: Consumer staples, health careIN CONTRAST, A DISTINCTLY uncrowded sector where strategists have feared to tread is financials, given the worsening fallout from the debt market. But it is precisely this aversion that leads David Bianco, UBS Securities' chief U.S. equity strategist, to nudge financials onto his roster of favored sectors (albeit behind industrials, energy and technology).
"Financial stocks have been priced for disaster," he says. Another catalyst: a belief that the Fed might soon cut rates to 4.75%, and financial stocks' historical outperformance as rates fall. Bianco likes big-bank stocks including Bank of America (ticker: BAC), in part for its 5% dividend yield, and capital-markets stalwarts like State Street (STT).
Robert Parker
Credit Suisse
S&P 500
Year End: 1500
12 Months: 1575
10-yr Treasury Yield: 5.20%
Fed-Funds Rate: 5.25%
S&P 500 Op Profits '07E: $102.60
'08E: $112
Favored Sectors: Technology, health care, telecom, mediaMeanwhile, the energy sector has shone in recent years and remains a proxy for global growth. Valuations remain modest, and cash-rich balance sheets help inoculate against constricting credit. "With powerful cash flow, the energy sector is not likely to be burdened with debt," notes Citigroup's Levkovich, who favors integrated oil and gas companies.
Tech attracts strategists for various reasons. Credit Suisse's Parker, for one, sees increased capital spending on technology infrastructure, especially on "tech nuts and bolts" companies like the network equipment bellwether Cisco Systems (CSCO). Merrill's Bernstein sees large tech stocks increasingly as stable defensive bets.
"A handful of large tech stocks have dividend yields better than the market," he says. In addition, some have lower betas, or are less volatile, than the market, and "sentiment toward tech has been so negative for so long."
François Trahan
ISI Group
S&P 500
Year End: 1700
12 Months: N.A.
10-yr Treasury Yield: 5.0%
Fed-Funds Rate: 5.25%
S&P 500 Op Profits '07E: $95
'08E: $103
Favored Sectors: Materials, industrials, technologyWhat keeps the strategists up at night? Wall Street expects the pillar that is the job market to hold up, even as financial-services firms cut more than 25,000 positions in August. So any signs of job weakness -- the unemployment rate climbing to 5%, or two consecutive months with job additions falling below 100,000 -- will cause consternation.
With S&P 500 profits increasingly supported by exports, the threat of protectionism -- and retaliation by trading partners like China -- also looms as a worry.
Monetary risk lurks, too. "If the Fed were to cut rates at a time when the European Central Bank is tightening, the dollar will just melt down -- and that's not a good scenario," Trahan says.
Measures of inflation have largely behaved since peaking a year ago, but BofA's McManus cautions against writing off inflation risk. "Most people expect a slight rise in unemployment to help quash inflationary pressure, but that's in an environment of commodity deflation," he says -- not today's backdrop of surging global prices.
Not surprisingly, all eyes are on commodity prices. "Firm commodity prices are a good indication of healthy global growth," UBS's Bianco says. After all, the strategists are counting on global growth to stay strong enough to prop up the U.S. economy, but not so strong that inflation is imported. It's a fine line, with little margin for error. |
