Light Ahead?

Arguing that there always have to be “one or two heretics in the crowd,” Balasa is watching for big gains in telecom–his expected “best performer” in 2003. If anything, this is “a function of how beat-up that industry is.” But Balasa warns not to make decisions in your portfolio “based on market performance for one week or one month or one quarter. Stick to your guns.” Those who abandoned the disciplined approach “have already regretted their decisions.” –M.L.F.

A “Surprising” Profit Rebound

Lincoln Anderson, LPL Financial

LPL Financial’s Boston-based chief investment officer thinks that monetary and fiscal policy are both moving “in the right direction.” And that, he believes, “coupled with the natural process of working through the business-side cost cutting,” will lead to a turnaround in the economy and a “surprising” jump in corporate profits. “Businesses have cut costs and increased productivity so much that you’ll see a really dramatic turnaround in earnings next year. And as the market starts to see that develop, it will start moving higher.”

Anderson especially sees healthcare, industrials, and banks as beneficiaries of the recovery. “The legislative, pricing, and regulatory environment will be more conducive to better performance in pharmaceuticals,” he says.

For banks, meanwhile, “very low short-term interest rates, along with somewhat higher longer-term interest rates and a pickup in loan demand” will tend to bolster earnings–especially for those that don’t have investment banking issues. But utilities are “going to take a while to turn around,” what with overcapacity problems and headaches for those that branched out into telecom. And the transportation sector, he feels, will “continue to grapple with cost problems associated with security–and it is not at all clear that you’ll get a sharp upturn in business travel.” Anderson is also cautious about the outlook for high-quality bonds. –M.L.F.

Slow Start, Then a Pickup

Anthony Chan, Banc One Investment Advisors

Banc One Investment Advisors’ chief economist thinks the economy will turn upward in 2003–but not before “a sharp slowdown” that could stretch well into the first half. “The economy has not stalled,” he maintains. “It has just not taken off. Even though it is making a little progress, especially in software, business capital spending is not likely to take off yet. And it is not strong enough to take over the torch from consumers,” who Chan thinks are “tapped out. The household debt-service burden has risen to one of the highest we have ever seen at the start of an economic recovery.”

Chan says his economic forecast tells him that “supercharged cyclicals” that depend on economic growth, such as technology and telecom issues, “are not going to take off.” He is also growing leery of bonds, arguing that “the second half of 2003 is when you start to worry about the Federal Reserve raising interest rates. And history shows that 100% of the time, when the Fed starts to raise short-term rates, long-term rates also start to rise.” By contrast, “healthcare continues to be pretty good,” says the Columbus, Ohio-based Chan. “It enjoys significant pricing power that other industries envy,” as does defense. “We are likely to be in for a long struggle,” he says. –W.G.

Are Lower Rates Bearish?

Richard Bernstein, Merrill Lynch & Co.

With the U.S. economy expected to begin accelerating by spring, Merrill Lynch sees S&P 500 operating earnings climbing to $53 per share by 2003, up from $46 this year and a meager $39 in 2001. As a result, says Bernstein, Merrill’s New York-based chief strategist, “our investment themes have a definitive late-cycle flavor,” with an emphasis on consumer staples, utilities, aerospace, defense, drugs, and energy, “and an underweighting in technology, telecom, consumer cyclicals, and consumer finance.” But Bernstein sees the overall market making little headway over the coming year. Unlike many of his peers, he views the Fed’s recent easing as bearish because it indicates “the economy is having trouble making the transition” from the early to the middle phase of an economic cycle.

On average, he notes, Wall Street strategists currently “believe that the current environment represents one of the best times to buy equities in the last 17 years.” In fact, Bernstein’s “sell-side indicator,” an index based on strategists’ recommended asset allocations, read a high 69.2 as of Oct. 31. But Bernstein takes a contrarian view of such bullishness. He contends that anything over 61.7% represents a “sell” signal. “In the last 17 years,” he says, “a true bull market–one fundamentally based and not a bubble–has never started with the sell side indicator above 50%.” –W.G.

Watch That Greenback

Gary Thayer, A.G. Edwards & Sons

A.G. Edwards’s St. Louis-based chief economist thinks that the economy will recover in 2003. He notes that the economy has already seen four straight quarters of growth, and earnings are once again on the rise. The bond market may not be getting that message–with its recent gains, yields seem priced at recessionary levels or worse. But Thayer believes that makes bonds “overvalued relative to stocks.” He therefore says he “would favor stocks over bonds over the next year”–as well as “very little allocation toward cash.”

But will investors regain their confidence and follow Thayer’s lead? He sees this as a critical “hurdle we have to get over.” Says Thayer: “Unfortunately, confidence follows the market; it doesn’t lead. Confidence probably won’t come back until the market is doing better and people are feeling better.”

Thayer says one key indicator to watch right now is the health of the dollar, which he is tracking “very closely.” With the Fed cutting rates, he thinks the dollar will decline 5% to 10% over the coming year. While that will add a bit to inflation, it also will “give companies a little more pricing power,” he says. “When the dollar was strong over the last two years,” explains Thayer, “it created deflationary pressures and made it very difficult for American companies to compete against imports. A lot of people focus on Congress and the Fed, but the dollar plays a very important role in companies’ ability to compete in the world economy. If the dollar declines as we anticipate, the business climate will improve substantially over the next year.” –M.L.F.

Deflation Is the Issue

A. Gary Shilling, A. Gary Shilling & Co.

Shilling, an investment advisor based in Springfield, New Jersey, warned IA readers at this time last year that “stocks are wildly overpriced.” Boy, was he on the mark. He still is an equity skeptic, yet he recently urged clients to pull some money out of bonds and put it into equities. However, he views this only as a short-term tactical maneuver after the market’s fall rally, rather than a fundamental change of sentiment. Shilling, in fact, is sticking to his guns on his forecast that the Dow Jones industrials will end 2003 at 7,000 and the Nasdaq at 1,000. And that, he says, will be after stocks rally back from even lower lows. “Stocks still aren’t cheap despite the tremendous pounding they’ve taken,” he asserts, “and I’m not sure we’ve seen capitulation. We haven’t reached the puke point yet.”

While Shilling sees the economy already reentering recession, he thinks recovery will be in place by year end, and GDP will stage a healthy snap-back by the fourth quarter. But he adds that overcapacity and deflation–perhaps of 2% annually–will continue to dog the economy and stocks for years to come. He is especially dubious on the outlook for consumer spending, and thinks that the housing sector, as well as auto and appliance makers, will be major victims. “Real GDP growth is going to be maybe 2.5%, not 3.5%,” he says. “And that doesn’t get you runaway growth in earnings or a P/E play.”

As a result, Shilling thinks stocks will likely provide nominal total returns of 4% to 7% in coming years. In real terms, that will bring the stock market back to around its long-run historical returns. However, that will come in an environment where prices are falling across the economy. No wonder, then, that among his recommended equity-market sectors are such defensive industries as REITs and utilities. –W.G.

In the end, only one of our panelists believes the market bottom has been seen, and five are predicting that a rebound will be evident within the first half of 2003, if not sooner. Two feel the dollar is an important indicator of economic strength, and another two believe the Fed’s actions will strongly determine the pace of an economic turnaround. But “it’s anyone’s guess,” concedes Balasa. The long-term perspective is what clients need to be reminded of–and that, according to all but one of our panelists, is cautiously positive.