IQ,
Are you becoming bearish or just believe that the SPH
is overbought at these levels and should retrace to
support before moving to new highs in the 1230 area..
And, what are your support areas SPH?.. Maximum downside
risk? Picking tops in this market has not been
$$$ wise.. As your fully aware.. Are you tempting fate? <gg>
Ross
This is Abby Cohens take on the markets:
****************
CHOPPY GLOBAL CONDITIONS CONTINUE; SUPER
TANKER AMERICA STAYS ON COURSE
A critical element of our views since 1996 has been the
difficult globalenvironment. Sluggish conditions among
our trade partners have slowed economicand profit growth
in the United States. Financial market distress abroad has
intensified volatility in our markets. Even so, the economy
and markets have continued to function well. The global
backdrop in 1999 will continue to offer impediments, but we
expect Supertanker America to stay its course of moderate
economic and profit growth. A supertanker is not necessarily
fast or colorful, but it is steady and reliable and hard to push
off course. The United States is not immune to global problems,
but several factors tend to mitigate the
impact.
First, the United States is the only major nation to have
demonstrated a growth dynamic in its domestic economy.
Importantly, American consumers have been encouraged by
notable improvements in the nation's labor markets. Unemployment
has declined, real incomes have increased and the mean duration of
unemployment for those who do lose their jobs has declined.
Even though corporatere structuring and downsizing activities
have continued, the United States has created more than 13 million
new jobs NET since 1993. Two-thirds of these jobs
pay above the median (not the minimum) wage. The nations of
Europe, with acomparably-sized population, have LOST one
million jobs net during the sameperiod. Millions of jobs have also
been lost in Japan.
Second, the United States seems less vulnerable than other
developed nations to problems among its trade partners. This
may seem odd considering that the United States is the world's
largest exporter. Further, exports had been one of
the fastest growing sectors of the U.S. economy until two
years ago, and their proportion in overall GDP had doubled
over the last decade. Even so, ports represent roughly 13% of the
U.S. economy, about one-third the proportion seen
in other industrial nations. (The numbers would be higher for
all nations if foreign direct investment was included.) Further,
much of the growth in U.S. exports has been in value-added
categories such as technology, computer service, financial
service, entertainment and publishing. The proprietary and
value added nature of these goods and services make them
less sensitive to changes in foreign exchange or the pace of
global GDP growth. Contrast this to the U.S. export mix of ten
to twenty years ago that was dominated by lower-level
manufacturing and production of fungible goods, such as
commodities.
Third, the solid U.S. banking system responded in admirable
fashion to dislocation in public debt markets in the summer
and autumn of 1998. When many corporations found it difficult
to issue new bonds, the nation's commercial banks stepped up
the pace of their lending. Commercial and industrial loans
have grown at a notably faster rate, 15% to 30%, in the second
half of the year. The combination of tough-love bank regulation,
and management emphasis on maintaining credit quality during
the long- lasting economic expansion, deserve much of the credit.
Fourth, the United States corporate sector was blessed by two
'impediments' in recent years that encouraged notable discipline
in their decision making. These included the (1) relatively high
cost of capital (when compared to other major
nations, especially Japan) that resulted in high threshold
levels of required returns, and (2) relatively tough accounting
standards.
During much of the current economic expansion, U.S. corporate
managers have demanded high returns from capital spending
projects, real estate, and other investments. As a consequence, measures
such as Economic Value Added (trade
mark) have never been stronger. U.S. shareholders and
accounting authorities have demanded high levels of disclosure
and transparency in corporate information. As a consequence,
data available to corporate managers, potential
investors and creditors have improved.
IGNORE THE AVERAGES
It will be best to ignore the averages--be they GDP, corporate
profits or stock price performance--in 1999. As always, many
investors will focus on whether GDP
of X% will lead to aggregate profit growth of Y% and so on.
We do not think that this will be the most useful exercise in
1999 (even though we continue to participate!). Instead, investors
will be better served by emphasizing the
developments below the surface. Averages tend to mask disparate
trends at the sector and industry level. This dispersion intensified
several quarters ago and we do not expect it to diminish in the
coming year. The dispersion was driven by a variety of factors,
importantly including the gap between U.S. domestic
and global economic growth. Further, the weakening demand
and excess capacity in several global 'commodity categories'
ranging from cement to semiconductors
was quite distinct from the tightening capacity and strengthening
demand in categories such as U.S. air transport and domestic
retailing.
Consider, for example, corporate profits during the first
half of 1998. While many investors quibbled about whether
aggregate S&P 500 earnings per share
were modestly higher or lower during the period, depending
on whether they prefer reported or operating data, the real
story was at the sector level. Let's highlight two important
sectors that showed dramatic earnings declines in 1998
that may now be well situated to generate earnings gains.
Semiconductor-related operating profits fell 50% during the
first half of 1998; they declined 80% on a reported basis. Yet,
many of these companies indicated toward year end that
their previously bloated inventory channels have cleared,
the demand for new products is solid, and that a positive
inflection point in earnings is near.
Stock prices have responded appropriately.
Another disappointing sector in 1998 has been
energy and energy-related stocks. Operating earnings fell
more than 20% in the first half of 1998 mainly driven
by the sharp decline in crude oil and other energy prices.
It is likely that supply and demand conditions will improve
in 1999. Consider that OPEC may reduce supply and that
two factors could improve demand. First, the recent
decline in the dollar relative to other currencies has
resulted in a reductionin energy prices (which are dollar-
denominated) in these other nations. An
important decrement to global energy demand over the
last two years came from Asia, where Japanese and Korean
users faced rising energy prices while the dollar strengthened
from 85 to 145 yen. They have just been treated to a
sizable cut in energy prices as their currencies have rallied
relative to the dollar. Second, there's still time for normal
winter temperatures to take hold.
Conclusions on equity valuation may also be skewed
by emphasis on averages. For example, we believe that
the S&P 500 is roughly at fair value based on our
views for the coming year. But several sectors appear to
offer more attractive value opportunities, and by implications,
other sectors appear far less attractive than 'the average.'
RISK AVERSION HAS SKEWED VALUATION AMONG
STOCKS AND BONDS
The notable volatility experienced in global markets did
not bypass the United States. Stock prices declined and
yield spreads widened in fixed income markets
indicating increased risk aversion on the part of most
investors. Interestingly, this risk aversion first appeared
in U.S. markets during the summer of 1997 when the
so-called Asian crisis began. The events of summer
1998 (i.e., Russia, Brazil, and dramatic delevering by
some financial participants) served to intensify these
trends. We believe that several interesting value opportunities
have resulted. Consider first the U.S. corporate bond market.
Yield spreads began to narrow dramatically during the
second half of 1996 at the same time that lower-quality
sovereign issuers had access to capital at yields close to that
of higher-quality issuers. Chairman Greenspan noted
the inadequate risk premia in a variety of global capital
markets during his Humphrey- Hawkins testimony in
early 1997 that immediately preceded a decision
by the FOMC to boost interest rates. The Federal Reserve
action in March 1997 did little to widen out these spreads.
However, the Asian crisis a few months
later did restore wider yield spreads, at least in the U.S.
domestic fixed income markets. U.S. investors recognized
that risk had not been properly priced in other markets
and moved to demand larger risk premia in domestic
markets.
This trend could also be seen in U.S. equity markets. The
risk premia for small- and mid-cap stocks widened notably
during the Asian crisis. Even though
many of the underlying companies had little direct impact
from Asian economic distress, their securities were priced
to reflect the increasing risk aversion of domestic
investors. The financial market disruptions in summer
1998 boosted the spread in risk premia between large and
small U.S. stocks to the widest we have ever seen. Despite
some recovery since October, good value opportunities
appear to exist among 'riskier' securities in the United
States. These would include corporate bonds versus Treasury
securities, and small-to-mid capitalization equities vs.
larger-cap stocks. We hasten to add that valuation
approaches are not timing devices; a catalyst must also
be present before goodrelative value transforms into
good relative performance. In the past, a
critical catalyst has been investor confidence in the
durability of economicand profit expansion. This would
be an essential element for improved
performance by both corporate bonds and small-cap
stocks. Company specificevents may also occur; for example,
currently low valuations may encourage
merger and acquisition activity involving smaller
companies.
FALLING INTO THE TRAP OF AVERAGES
Despite our conviction that averages will mislead I
n 1999, we nevertheless provide some guidance on
what we expect. First, S&P 500 operating earnings per
share are expected to grow, on average, 5%-7% during 1999. (Need
less to say, we do NOT foresee recession in the coming
quarters.) Profit growth will be helped
by somewhat easier comparisons given that the impact
from weaker Asianconditions and FAS 128 were first felt in
late 1997. FAS 128 led to mechanical
changes in the calculation of earnings per share and resulted
in an approximate 2% downshift in S&P 500 eps in the fourth
quarter of 1997.
Second, we expect 'normal' stock price gains, on average.
Our year end 1999 price target for the S&P 500 is 1275. The
rough equivalent for the Dow Jones Industrial Index, for which
we do not prepare the same detailed analysis of
earnings or valuation, is 9850.
Third, we expect stock price volatility to return to the 'normal'
levels experienced prior to summer 1998. Note that standard
deviation of daily price change had roughly doubled between
the low levels experienced in 1992 through
1996 and the more 'normal' levels of 1997 and the first half of 1998.
In conclusion, stock selection and sector rotation should matter
a great deal to equity portfolios in 1999. If average equity returns
are good (but not abnormally good), investors are likely to accept
more risk in exchange for potentially larger returns. When
valuation disparities exist, as they do now,
returns to non-indexed approaches may be enhanced. Finally,
higher volatility tends to encourage more portfolio turnover and
sector rotation.
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