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WHAT'S COMING? SLOWER GROWTH AND LOWER PROFITSDespite rate cuts, stocks will still be moving into a stiff windWhat happens in the economy will have a big impact on how well your investments perform in the next year or so. After all, economic growth, employment, and interest rates have all helped drive the market's gyrations in recent months. Here's what to expect next: Interest Rates Will Plunge. Anyone who doubted the Fed's direction after its Sept. 29 quarter-point cut ought to have been persuaded by the surprise one-two punch of the discount and federal funds rate cuts on Oct. 15. Those who still aren't convinced will be soon because the Fed isn't finished slashing. By mid-1999, we at Standard & Poor's think the fed funds rate will be 4% or lower -- down from 4 3/4% today. The low point for this cycle, in fact, could be down to the 3% seen in 1992-93. Rates on intermediate and long-term Treasuries, including the long bond, will drop as well. But we don't expect yields to decline across the board on higher-risk junk bonds because economic growth is slowing and recession risks are on the rise. Growth Will Slow. We think the U.S. will avoid a full-blown recession, but the economy is likely to suffer with sluggish growth over the next few quarters. In the first half of 1999, we expect economic growth to be about 1%, compared to over 3% for the same period this year. What's behind the subdued economy? First is slow growth in consumer spending (which is merely returning to normal after running 100 mph in the first two quarters of 1998). Second is virtually no growth anywhere else -- thanks to Asia, government spending curbs, and businesses not interested in building new factories when older ones are sitting idle. Corporate Profits Will Suffer. Slower economic growth does not bode well for corporate profits -- when the economy sniffles, profits usually come down with a nasty cold. Further, salaries are climbing, and inflation is very low. This is good news for consumers, but it's bad news for investors because it squeezes profits at a lot of companies. Overall, we see earnings up only slightly this year and next. Not until 2000 do we have a shot at double-digit gains in S&P 500 earnings per share. Given this tepid forecast, what's an investor's next move? Falling interest rates are certainly a big plus for stocks (see "Proof That the Market Does Love a Rate Cut"). The Fed's surprise double-cut sparked six consecutive days of rising stock prices. But don't assume that everything is going to march skyward the way it did last year. The profit squeeze is a big problem, and significantly better profits are still two years away. So the risks in stocks are still there. Stocks may look like bargains now (even after the recent run-up), and while some really are, a lot of others will fall from favor when the earnings fail to materialize in the next quarter or two. If you're a long-term investor who rode out this summer's market swoon, hold on and stay in -- your confidence is likely to be rewarded in the next year or so. If you're a long-term investor who took money out of the market in the recent turmoil, you should consider putting some of it back in soon. But remember: This is still a volatile trading market -- and no one ever calls the exact bottom -- so you'd be well advised to move back in gradually. If you seek refuge in bonds, be wary of those with low credit ratings. Those low ratings may not matter much when the economy is surging ahead, but experience in past slowdowns shows they mean a lot in slower economic times. No matter what, if your time horizon is just two or three years or less, this isn't the kind of stock market you want to play games with. Stick with short- to intermediate-term investment-grade bonds. Given the flat yield curve and how nervous some people are, money market funds aren't a bad idea, either.
By David M. Blitzer, vice-president and chief economist, Standard & Poor's RELATED ITEMS
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Updated Oct. 29, 1998 by bwwebmaster
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