THE BULL HAS ONLY BEGUN TO CHARGE
Hard-charging, determined, and utterly macho, the bull has long been a symbol of rising markets. With a 59% gain over the last three years, things have been so good for so long that a growing number of investors fear the bear will come out of hibernation and maul the aging bull. But perhaps the most fitting symbol of the stock market today is neither bull nor bear, but bunny. You know, the rabbit in the battery commercial, the one that keeps going and going and going....
The bunny's batteries still pack a lot of energy. They're charged up with the power of low interest rates, rising corporate profits, and plenty of cash. That money is coming from individual investors via equity mutual funds. In the first 10 months of the year, the funds took in more than $100 billion, and they continue to collect money at a brisk rate.
SURPRISES. So 1994 is shaping up as a good year for the equity market, mainly because the economy--32 months after it officially emerged from recession--is finally starting to show some decent growth, and that's already showing up in corporate profits. Elaine M. Garzarelli, director of sector analysis at Lehman Brothers Inc., notes that since the third quarter, twice as many companies have been reporting "positive earnings surprises"--better than expected--as negative surprises. Says Garzarelli: "That will make analysts start to raise earnings estimates, and that always helps the stock market move higher."
Higher profits and a stronger economy could cause the Federal Reserve to push up short-term interest rates. That would have been a disaster for the stock market a year ago, but a modest increase shouldn't be a problem now. The first part of a bull market gets its strength from falling interest rates and the liquidity it provides. The second phase gets its strength when earnings accelerate, and that's the stage the market is in now. The big problem comes when earnings growth decelerates or interest rates accelerate. Neither should be a problem in the near future.
That's why strategists are upbeat about 1994. Abby Joseph Cohen, co-chairman of the investment policy committee at Goldman, Sachs & Co., figures stocks should deliver a total return (appreciation plus dividends) of about 12% to 14%. That may not sound like a lot, but the average annual total return for stocks is 10.3%. If Joseph is right, the Standard & Poor's 500-stock index, now at 466, could climb as high as 516, and the Dow Jones industrial average, now at 3764, up to 4150.
PRICEY PURCHASE. Even one of Wall Street's least bullish strategists, David Shulman of Salomon Brothers Inc., doesn't think there will be a disaster. "It will be a more difficult year than 1993," he says. Still, Shulman expects the S&P 500 to stand 8% to 9% higher when the books are closed on 1994. Counting dividends, that's still an 11% return, which beats what investors will do in bank accounts or even bonds.
If the forecasters are right about 1994, the stock market will deliver positive gains for the fourth year in a row. That strikes an increasing number of investors as unlikely. Why? The market is starting the year with the major averages at record high levels, dividend yields are near record lows, and valuation measures such as price-to-book ratios and price-to-earnings ratios are also reaching for their highs. "I like to buy what's cheap, and by no means are stocks cheap," says Robert A. McLaughlin, chief investment officer for the $29 billion Ohio Public Employees' Retirement System. Over the past 15 months, he has cut the pension fund's stock allocation from 30% to 11%. "That's less than I had on the eve of the October, 1987, crash," he notes.
The bearishness grips newsletters whose readers are mainly individual investors. The publication Timer Digest, for instance, recently collected the 1994 forecasts of 40 such newsletters. The tally: 60% bearish, 40% bullish. In addition, the bears were also far more downbeat than the bulls were optimistic. The bears' average forecast was a 16% drop; the bulls came up with an 8% gain. All ef this bearish sentiment gives the stock market a lot of room to move up. Market tops are usually punctuated by excessive optimism and an absence of pessimism.
IT'S SAVINGS TIME. Of course, sentiment indicators can change quickly. But there are underlying forces in the economy that are turning investor dollars toward stocks, and such trends take years to play out. The billions that have poured into equity mutual funds since 1991 are not only a response to lower interest rates. Demographics is playing a major role as well, as baby boomers move into the age when individuals build up savings. They're choosing stocks because of their superior long-term returns.
For much the same reason, some market-watchers think pension funds will also be forced to increase their allocations to stocks. At current and prospective rates of returns, bonds just won't generate enough of a return to meet the funds' long-term obligations. "That's the next wave of money to hit the stock market," says Edward M. Kerschner, chairman of PaineWebber Inc.'s investment policy committee. When the money hits the market, it will continue to hunt for opportunities in economically sensitive stocks, or cyclicals, much as it's done all year. That's why the Dow industrials, up 14%, has outpaced the S&P 500, which has only gained 6.9%. Cyclicals weigh more heavily in the Dow than in the S&P.
In fact, the brightest spot in the Dow so far this year is the cyclical General Motors Corp. At 56, GM is up 78% so far this year, and on Dec. 9 finally beat the all-time high set in 1965. The other automotives are racing along as well. Chrysler Corp., up 75%, and Ford Motor Co., up 50%, are also in the fast lane. Market analyst Laszlo Birinyi, who tracks money going in and out of stocks, says the automotives are still compelling buys. "Every time the stocks pull back a little, fresh money comes rushing in."
Many pros also rank the housing industry, helped by low interest rates and more affordable home prices, as a buy for 1994. That includes homebuilder Centex Corp. and companies that make any kind of item for the home: Crane for plumbing fixtures, Whirlpool for appliances, or Ethan Allen for furniture.
DRAWN OUT. Another important theme for 1994 is "productivity." That's the buzzword for companies whose products "help business do more with fewer people or get more out of human labor," says William E. Dodge, market strategist for Dean Witter Reynolds. Productivity plays include Deere, Fluor, and Ingersoll-Rand in capital goods, and computer-related companies like Compaq Computer, Intel, Microsoft, Motorola and Oracle Systems.
Tech stocks are alluring to foreign money managers who hold U.S. technology in high regard. "European clients tell me if you're serious about the whole technology story, about multimedia delivery and telecom services, you have to end up in U.S. companies," says Michael Young, Merrill Lynch's London-based investment strategist.
Even the most upbeat investors fret that stocks have not had the 10% correction typical of bull markets. But then again, this is no typical bull market. The economy didn't come out of recession with hard-charging gains but amassed its strength slowly and is far from peaking. Likewise, the market advance linked to the economy is likely to be a drawn-out affair. Should the stock market bunny lose power sometime in the next few months, relax. The batteries aren't dead: all they need is a little time for recharging.STOCKS FOR AN EXPANDING ECONOMY
Stock Price* P-E ratio** Dividend yield
AMR 68 3/8 13.5 NA
A strike wiped out '93 profits, but analysts think cost-cutting, lower fuel
prices, and a better economy will make the airline soar in '94.
CENTEX 39 3/8 12.9 0.5%
Housing is more affordable than it has been in two decades, which is great news
for a company that builds new homes.
CHASE MANHATTAN 32 5/8 7.5 3.7
Fear of higher rates makes many shun bank stocks, but with more capital and
lower costs, money-center banks can still deliver gains.
DEERE 69 1/2 13.6 2.9
Leading manufacturer of farm and construction equipment should prosper with
improving world economy.
FLUOR 42 18.9 1.2
This engineering and construction company builds the industrial infrastructure
that's needed in developing countries.
FORD MOTOR 64 3/4 11.3 2.5
The Big Three are all booming. Ford, which is up only 51% this year, may be the
best play for '94.
IBM 57 3/8 28.4 1.7
Analysts are finally saying nice things about Big Blue, yet institutions own
little of it. Good news on profits could trigger a buying stampede.
INTEL 57 1/2 9.8 0.4
Its chips are the brains of most computers today and will probably continue to
be in the future. Stock is cheap.
KNIGHT-RIDDER 59 3/8 18.2 2.4
Advertising lineage is picking up along with the economy, and that's a plus for
one of the nation's largest newspaper publishers.
WMX TECHNOLOGIES 27 1/4 14.6 2.2
Stock so beaten up, there's little downside risk. Better economy should lead to
higher trash volume and fatter profits.
*Dec. 13, 1993 **Based on 1994 consensus earnings forecasts from
Institutional Brokers Estimates System
DATA: BUSINESS WEEK INTERVIEWS WITH PORTFOLIO MANAGERS AND ANALYSTS
Jeffrey M. Laderman in New York