As Wall Street firms hold their annual year-end market outlook briefings in New York in December, each is maintaining a bullish stance, predicting the economy will rebound in 2002.
Bruce Steinberg, Merrill Lynch's chief economist, said the U.S. would continue to feel the chill of recession throughout the winter, but could expect a recovery to settle in by spring. "The global economy is in a synchronized global recession," Steinberg said. "The U.S., Europe, Japan, and the emerging markets are all in recession. Until September 11, we weren't sure that the U.S. would be in a recession." The uncertainties that followed September 11, he says, stymied capital spending. As a result, the longest expansion in U.S. history came to an end. Third quarter gross domestic product shrank to a 1.1% annual rate and fourth- quarter GDP is contracting at a similar pace. "GDP will continue to decline into the 1st quarter, and corporate America must downsize further," he says. "But "by the end of next year, we will see a synchronized global upturn."
Economists are also confident that Fed easing will spark further economic expansion. "Fed policy works," said Alan Levenson, T. Rowe Price's chief economist. "We are not headed for deflation; we will get a recovery next year. It will not be the 5%, 6%, or 7% growth rate [of past years], but rather growth of 4%." Steinberg predicted a 5% growth rate for the U.S. economy next year.
Putnam Investments' senior investment team predicts in its Capital Markets Outlook report that "the worst is behind us and that world equity markets will register moderate overall gains in 2002, led by the United States." The team predicts a fair value of 1,325-1,350 for the Standard & Poor's 500 by year-end 2002. Putnam economists forecast a recession will linger until the second quarter, "with no substantive improvement in corporate profits until next year's second half."
Equity markets will rise in 2002, in part because investors have placed too much money in low-yielding money market funds. "There is $2.3 trillion in money market funds," points out William Fitzgerald, managing director of Nuveen Investment Management, Nuveen's fixed income investing division. This figure "engulfs the size of the Federal budget, which is $2 trillion." Putnam Investments' team agrees, stating the equity markets are currently undervalued. This conviction, Putnam said in its report, "rests partly on the belief that puny bond and money market yields will drive investors into equities."
Richard Bernstein, Merrill Lynch's chief U.S. strategist, said investors are not taking advantage of "unusually attractive" higher-quality U.S. stocks. "Higher-quality stocks are cheaper than lower-quality stocks, which means investors are making a big bet on cyclicality. People are not running to safe haven stocks." He says investors are "paying better prices for Volkswagens. We prefer to look at the Bentleys, and pay Volkswagen prices for the Bentleys."
Bernstein said his favorite sector is utilities, followed by consumer staples, which he termed "the forgotten sector" that yields more than energy stocks. Healthcare was next; the stocks are not cheap, he said, but there are defensive qualities in the earnings of these companies. The aerospace and defense sectors were next on the list; he said these sectors hold the most promise for new technology opportunities in 2002. And investors should look to only the highest-quality financial stocks in the New Year, like government-sponsored enterprises (GSEs), insurance companies, and asset managers.
John Waterman, chief investment officer for Rittenhouse, Nuveen Investments' separate accounts manager, said that in these uncertain times, investors should not chase hot stocks but instead focus on diversification--with a mix of value stocks, small stocks and bonds. "The message is 'Be diversified and don't try and time the market. Don't chase the hot return sectors or hot stocks.'"