Will the bull market survive the storm?
Investors eked out modest gains last year, but now ill economic winds are whirling through Wall Street.
from the January 7, 2008 edition
Page 3 of 3
Since corporate profits are shrinking, investors are more willing "to pay up" for dividend-paying stocks with predictable earnings growth, says John Merrill, president of Tanglewood Capital Management in Houston.
Large-cap stocks are reasonably valued from the standpoint of price/earnings ratios and price-to-book metrics. Many technology, healthcare, and food and beverage stocks fit the mold of defensive growth stocks, Mr. Merrill says. "But I would avoid most financial stocks until we get greater clarity on the quality of the banking industry's assets," he concludes.
Looking forward, investors may want to turn more defensive, for instance, by trimming small-cap or emerging markets exposure and adding to cash reserves. According to Charles Schwab & Co., a moderately conservative portfolio with a 40 percent allocation to equities, 50 percent in bonds, and 10 percent cash would have lost only 3 percent in down years between 1970 and 2006.
Raise the stock portion to 80 percent, holding 15 percent in bonds and 5 percent cash, and your average loss would have been three times greater.
"The first half promises to be bumpy, as the economy struggles to avoid recession," says Fred Dickson, chief strategist at D.A. Davidson in Great Falls, Mont. "You have to be concerned about additional huge write-offs by banks and other financial companies, and the implications those write-offs could have for corporate and consumer lending. A likely spate of negative fourth-quarter earnings surprises, bad news on the inflation front, and rising joblessness doesn't bode well for stocks over the near term," he says.
Maybe not recession, but 'mild stagflation'?
So far, the Fed's steps to lower interest rates and relieve the credit crunch have had a limited effect. Despite a consensus view that the Fed will lower its benchmark funds rate again in January, high oil prices and a sagging dollar don't give the central bank much wiggle room, according to Chuck Zender, portfolio manager at Leuthold Group in Minneapolis.
While Mr. Zender doesn't foresee the economy tipping into recession, he predicts "mild stagflation," defined as sluggish economic growth combined with inflationary pressures, which historically depresses stock valuations.
"A high single-digit rise for S&P 500 appears achievable this year," says Stanley Nabi, vice chairman of Silvercrest Asset Management in New York. "But most of the market's progress is likely to occur in the second half of the year, when the economy is likely to stabilize and corporate profits prospects brighten." Historically, he notes, markets tend to strengthen following national elections.
With credit markets in flux, fixed-income investors are advised to stick with high-grade corporate bonds. Last year, a "flight to safety" sentiment lifted returns on long-term US Treasury securities to 8 percent.
This year, bond markets are likely to show more stability, with prices of high-quality corporate issues likely to rise as bond yields ease, analysts say.
For higher-tax-bracket investors, municipal bonds have special appeal. Many high-grade tax-exempt bonds currently pay out more than 10-year Treasuries do. FDIC-insured bank certificates of deposit, some of which now yield close to 5 percent, are another way to ride out volatile markets with less anxiety.
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