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Politics : Idea Of The Day -- Ignore unavailable to you. Want to Upgrade?

To: Narotham Reddy who wrote (24120)	3/7/1999 2:14:00 AM
From: IQBAL LATIF	Respond to of 50167

Stock trends Profitable prosperity By Robert S. Salomon Jr. THERE IS ONE CARDINAL PRINCIPLE on which all investors readily agree—earnings expectations drive stock prices. Disappoint those expectations and prices collapse. Exceed them and prices climb. This is equally true for the market as it is for individual stocks. Why is this important to reflect on now? Because the consensus viewpoint is that earnings will be disappointing this year—and the consensus is, I think, far too pessimistic. Experts making top-down forecasts for the S&P 500 (experts, that is, who are market strategists as opposed to industry analysts) predict flat earnings in 1999. The most significant factors contributing to this subdued forecast are the continued lack of pricing power in the manufacturing sector and rising labor costs. Despite these concerns, my belief is that this expectation will prove to be way too conservative and that profits will instead be up, at least 8%. If you buy my profit outlook, you won't be terrified by the market's steep multiple, 32 times trailing earnings. Here's my justification: • Real growth in the U.S. economy should be 3% this year, extending the longest recovery in the postwar period. The turn of the century could easily see a global boom resulting from the lagged effects of interest rate cuts and monetary stimulus around the world. -------------------------------------------------------------------------------- Most economic forecasts for this year are just a simplistic extrapolation—and far too pessimistic. -------------------------------------------------------------------------------- • Business consolidations will eliminate substantial redundancies in many industries. Even though this has been going on for some time, there are two significant new entrants—paper, with the merger of International Paper and Union Camp; and oil, with the merger of Exxon and Mobil. These consolidations are an attempt to maintain margins in an era of declining commodity prices. • Massive spending that has been going on for several years to remedy Y2K problems will begin to dissipate, creating an unexpected dividend spread over the last half of this year and the first half of next. • Technology will deliver an important, albeit difficult to measure, productivity gain to the service sector. This gain will hold unit labor costs in check. • Last year profits were depressed by specific events not likely to recur any time soon—the GM strike and the losses sustained by financial intermediaries resulting from the Russian default and widening credit spreads. • The collapse in oil prices, although it will depress profits for the oil producers, will act like a tax cut for individual consumers, stimulating demand. For industrial consumers, fuel and raw material cost declines will enhance profit margins. Last year the economy grew nicely and produced no improvement in profits (i.e., a profitless prosperity). This has led to similar forecasts for this year, really just a simplistic extrapolation. The rhetoric explaining this forecast argues that low or nonexistent inflation is bad for profits. On the contrary, lack of pricing flexibility causes managements to focus even greater attention on operating efficiency. It is important to note that profits produced from improved productivity are worth more to investors because they represent higher quality and greater sustainability than those produced from raising prices. Anyone who doubts this need only compare valuations in the 1970s with those in the 1990s. The sectors fueling the general increase in profits are technology and financial services; these sectors also have the greatest potential for pleasant earnings surprises. I recommend Cisco Systems (99, CSCO), Compaq Computer (42, CPQ), Lucent Technologies (98, LU), Gateway 2000 (68, GTW), Xerox (115, XRX), Allstate (38, ALL), American Express (102, AXP), Citigroup (53, C) and Morgan Stanley Dean Witter (90, MWD). These high-quality stocks ought to appreciate by 20% or more, on average, over the next year. Robert S. Salomon Jr. is principal and founder of Stamford, Conn.-based STI Management. Research analyst: Deborah H. Tarasow.