Outlook: Anxious, but upward

Their outlook for 2000 remains positive, thanks to an strongly growing U.S. economy.

Low unemployment, low inflation and a recovering global economy all point to higher company earnings and a strong market this year.

But the analysts have a list of concerns just as long: Tech stock earnings could disappoint; inflation could reappear; the Federal Reserve could raise interest rates; consumers might begin to spend less, weakening sales and earnings; and the dollar could weaken.

Slower Growth

Though generally positive, the experts do predict the market will slow from 1999’s pace. Technology stocks, which drove the market, are overvalued, they say, and the market will eventually have to correct itself.

“You can make arguments that we’ve had an adjustment to some new equilibrium for p/e ratios, but you can’t expect those to keep going higher,” says Scott Brown, chief economist at St. Petersburg, Fla.-based Raymond James Financial Inc. He believes that gross domestic product growth will be closer to 3% in 2000 than the 4% of the past few years.

Alan Skrainka, chief market strategist at St. Louis-based brokerage Edward Jones, agrees. “I think common sense is beginning to return to the market,” he says. Mr. Skrainka predicts a 10% return for the Dow Jones Industrial Average, based on his expectation that net U.S. corporate earnings will increase 14%.

But when the market correction comes is a matter of speculation, says Stuart Schweitzer, global investment strategist at J.P. Morgan & Co. “Eventually valuation is going to matter, but valuations need a catalyst before they can be corrected,” he says. “That means we need to have a significant slowing in economic activity globally, and some disappointments in corporate profits here in the U.S.”

INTEREST RATE FEARS

“After getting through Y2K, people are wondering what’s going to slow the market. Well, (Federal Reserve Board Chairman) Alan Greenspan is,” says Phil Dow, chief equity strategist at Dain Rauscher Corp. in Minneapolis.

In fact, he says, the market may endure all year the volatility seen during last week’s plunges of both the Nasdaq Composite Index and Dow Jones Industrial Average.

“It’s the first time in several years that we’ve had synchronized global growth and that’s putting upward pressure on interest rates,” says Mr. Schweitzer. “People are worried it’s going to be the end of the expansion.”

Mr. Schweitzer and other strategists, however, believe that the central banks are going to succeed in heading off any inflation problems.

“Unless interest rates go to the moon, the economy and the markets should be all right,” he says.

After the worst bond market in years, strategists say it may finally rebound in 2000. “If the Fed is too successful at slowing down the economy, we could see the 30-year Treasury go back below 5.5% the second half of the year,” says Mr. Brown.

Mr. Schweitzer thinks stocks are fundamentally good, although he predicts 30-year-bond yields will push toward 7% by the end of the year, which will help slow down the economy.

International allure

U.S. markets should also get a boost in 2000 from the strong global economy. “Europe will have its best year of growth in a decade,” says Mr. Skrainka. “A strong recovery is still in place in Asia.”

That Standard & Poor’s 500 stock index companies get just 58% of their earnings from the United States means that the earnings outlook is very good for companies that did very poorly last year, such as McDonald’s, Disney, Gillette and Coca-Cola.

Mr. Schweitzer believes the markets in Japan and Europe are a better value in 2000 than the United States, simply because they have much more room for growth.

Joe McAlinden, chief investment strategist at Morgan Stanley Dean Witter & Co., is less matter-of-fact .

“Sometimes cross-border effects are perverse and hard to forecast. Sometimes they’re the opposite of what you might intuitively think.”

In the Pacific Rim crisis of late 1997, he points out, Asia’s pain was Wall Street’s gain. “You had the rapid onset of severe recession over there. Meanwhile Americans were buying gas for 99 cents a gallon, giving them money to spend elsewhere.”

Safer not to make too many assumptions based on strong economic conditions here or abroad, warn strategists.

Says Mr. McAlinden: “The conventional wisdom is that Y2K didn’t blow everything up, so the economy is stronger than we thought. But I think it may go through disequilibrium.”

Three Hot Sectors

Looking strongest are technology, health care and financials. Dain Rauscher’s Mr. Dow likes companies that are moving more of their business online, like Wells Fargo & Co. “It’s the bank using the Net the best.”

Mr. Skrainka also likes financials, which he says will “be under pressure short term, but provide good value for the long run.” Telecommunications, pharmaceutical and technology companies look to remain strong in 2000 as well, he says.

Whether the performance of small-caps will continue to improve in 2000 is hard to predict. Mr. Schweitzer says he’s inclining toward small stocks, which “are cheap, and their earnings expectations have come back down to earth, except for the technology area.”

Mr. Skrainka, however, is still staying away from small-caps, noting that earnings in the S&P 100 in the fourth quarter of 1999 were up 24%, while small-cap earnings in the S&P 600 grew at 1.5%. “Small-caps have underperformed the market every year since 1994.”

Some Fears Remain

Mr. McAlinden predicts a slowdown as a delayed reaction to the year 2000 hullabaloo. “As companies use up computer chips and cardboard boxes they may have stockpiled, we might see an unexpected slowing in the GDP rate,” he says.

Mr. Schweitzer shares fears with the Fed that inflation could come back to haunt. “If wage growth picks up, that’s going to be a problem.”

Alfred Kugel, senior investment strategist at Stein Roe & Farnham in Chicago, predicts only a slight increase in inflation, as imports limit companies’ ability to raise prices.

Greg Valliere, managing director at Schwab’s Washington Research Group, frets that “a nasty correction would prompt consumers to start saving again, softening the economy. The good news,” he says, “is interest rates would eventually fall.”

Another possibility raised by Fritz Meyer, manager of the $150 million Invesco Growth & Income fund, is a depreciating dollar. “If the dollar were to start depreciation substantially because of strength in the rest of the world,” leading to demand for other currencies, “that would concern me.”

The most likely curveball, however, is the tech sector. Ron Spaulding, chief investment officer of Safeco Corp. in Seattle, says he’s extremely worried about the “bubble bursting. There will be some winners and losers in this dot-com story,” he says. “But the losers will fall hard. And I fear they’ll bring down the whole sector and the whole market.”

The good news, says George Cohen of Cohen Klingenstein & Marks, which manages $4 billion, largely in institutional money is that productivity will continue to grow at higher-than-historical rates.

“The same dynamics are in front of us as behind us,” says Mr. Cohen. “I see at least two years of strong productivity, with inflation staying away.”

In other words, this year, like last, looks to be angst-filled but prosperous. “The market will be up for the year,” says Mr. Skrainka of Edward Jones. “But it will be a bumpy ride.”

Related Topics: Investment Strategies