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Forecasts December 20, 2007, 5:00PM EST

What the Pros Are Saying

(page 2 of 2)

Ralph J. Acampora Brian Maranan Pineda

Stuart T. Freeman Mark Katzman

Elaine Garzarelli Brian Maranan Pineda

Ben Inker Shawn G. Henry

Robert Arnott Thomas Michael Alleman

Laszlo Birinyi Richard Freeda/Aurora

Our models show the S&P 500 is undervalued by 25%."

Garzarelli is advising investors to buy some of the most beaten-down stocks, including those of giant financial institutions such as Lehman Brothers (LEH), Bear Stearns (BSC), and Merrill Lynch (MER). What would cause her to turn bearish? Not much. "Our indicators are extremely bullish."

BEN INKER, DIRECTOR OF ASSET ALLOCATION, GMO

During the bear market that ended in 2002, institutional money manager GMO made timely bets on Treasury inflation-protected securities (TIPS), real estate investment trusts, and emerging markets equities. With the Boston-based firm anticipating a stock market decline in 2008, "there's nothing we love," admits Inker. Although U.S. stocks appear reasonably valued at 15 times next year's projected earnings, Inker thinks the market is a lot more expensive.

Why? Earnings are not measured the same way they used to be. While historical price-earnings data are based on net earnings, analysts now use operating earnings, which tend to inflate the collective bottom line by about 15%, he says. Of course, as the "e" in p-e rises, the ratio falls, making the market look cheaper. Moreover, with the average forecaster still looking for a modest uptick in earnings in 2008, Inker thinks "the market will be vulnerable" if the consumer retrenchment he expects causes earnings to fall short.

For 2008, GMO recommends building a defensive portfolio, with a 25% allocation to cash and a further 25% in bonds. It's putting only a tiny 13% slice into U.S. stocks. Instead, Inker favors foreign stocks. With lower p-e ratios than their U.S. counterparts, they have better odds of "surviving a disappointing profit environment," Inker says. Are emerging markets tapped out? After a strong rally, "we're less excited than we were. But if the world holds together, we could have another decent year."

ROBERT ARNOTT, CHAIRMAN, RESEARCH AFFILIATES

Widely followed on both Wall Street and in academia, Arnott has a reputation for thinking outside the box. While most prognosticators expect stock prices, corporate earnings, and economic growth to post small gains in 2008, Arnott, whose money management firm is in Pasadena, Calif., thinks all three have nowhere to go but down. Why? He expects sliding home prices and rising mortgage defaults to prompt consumers to curtail spending sharply in 2008, pushing the economy into a mild recession. Moreover, he adds, with "wages at their lowest percent of GDP ever" and corporate profits at their highest level in 40 years, "how likely is it that we will see earnings surge from current levels without a political backlash?"

Arnott advises riding out the storm in a portfolio that's 50% in bonds and 20% in cash. While most on Wall Street dismiss the threat of inflation, he recommends TIPS and commodities, in part to guard against the inflationary impact of a declining dollar.

He recommends putting just 20% into U.S. and international stocks. For now, he favors one of the most defensive sectors, utilities. But he predicts a "marvelous recovery" in financial stocks in the second half of 2008. Although Arnott likes emerging markets, he prefers the debt to the equity, since he believes the former is more reasonably valued. "A lot of these countries are in better fiscal condition than the U.S.," he says.

LASZLO BIRINYI, PRESIDENT, BIRINYI ASSOCIATES

A Wall Street veteran who landed his first job at a financial services firm, Auerbach, Pollack & Richardson, in 1972, Birinyi has seen many market crises. The current one doesn't faze him much: "Based on historical data, I articulated a principle some years ago that has been very profitable for me," he says. According to Birinyi's "Cyrano principle," "if the concerns of the market are as obvious as the nose on your face, the market and monetary policymakers will have an amazing ability to adapt and adjust." He believes the Fed will do what it takes to calm the credit crisis.

Birinyi thinks the bull market that started in 2002 is still very much intact. He expects the current economic expansion to continue, with 5% corporate earnings growth helping to propel the Dow to 15,000 by the end of 2008. The signs of a market top, which include speculative fervor and rising stock valuations, "really aren't present," he adds. At 15 to 18 times estimated earnings—the exact number depends on how you measure earnings—stock market values are neither cheap nor expensive. If the market were a traffic light, Birinyi says, it would be flashing a yellow signal now.

Birinyi sees "pockets of value." With risk aversion rising, he thinks investors will pay more for such predictable growth stocks as Google (GOOG) and Deere (DE). He expects commodity prices to keep rising "as the emerging markets continue to emerge." He also favors buying stocks which were "excessively punished" in the recent subprime-related meltdown. They include retailers Tiffany (TIF), Nordstrom (JWN), J. Crew (JCG), and financial giant American International Group (AIG).

To read forecasts from other stock market strategists, see "Where to Put Your Cash in 2008".

Back to Investment Outlook 2008 Table of Contents

Tergesen is an associate editor for BusinessWeek in New York .

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