Analysts Mull 1997 Outlook After Profitable 1996

If investors see stock prices as vulnerable to a downturn, they may want to consider bonds, money market funds, and REITS

Investors are ringing out 1996 with mixed feelings. In financial terms, '96 turned out to be a great year for the stock market, following an even more spectacular year in 1995. The Dow Jones industrial average is up about 28 percent in '96; the Standard & Poor's 500 stock index is up almost 23 percent.

Can 1997 be equally profitable? In '96, the market was driven by large, blue-chip companies, plus technology stocks. But that doesn't mean they'll be repeat winners in '97.

Here are answers to some frequently asked questions about the 1997 financial climate.

Some analysts say we could have a major market downturn in 1997. How seriously should we take the forecasts?

Most investment houses believe there will be no major downturn of 15 percent or more in 1997, although there could be a minor correction of about 10 percent. The consensus view: Even with a minor correction, the market should rise at least 10 percent in 1997.

Still, almost all forecasters agree on prudence this year. Many mutual fund companies have been quietly adding special lines of credit, in case of unusually heavy redemptions.

First years of new presidential terms tend to be lackluster for stocks. Moreover, back-to-back market gains of 20 percent or more, as occurred in 1995 (when the Dow was up 36 percent) and '96, are rare. The few times this century when there have been such huge gains (including 1904-05, 1927-28, 1935-36, 1954-55, and 1985-86), have been followed by sharp downturns in the third year, as speculative fervor peaked. (The only exception came in 1924-1925.)

That is not to say that history will repeat itself. It does suggest that attention to one's finances may be more important than usual.

Does that mean one should avoid the stock market in '97.

Not at all. But, says Rao Chalasani, chief investment strategist for investment house Everen Securities Inc., Chicago, people should know why they are investing in a specific stock or mutual fund. Just throwing money into the market without forethought could be unwise.

Mutual-fund companies repeatedly tell us that "timing the market" is bad - that private investors should leave their money in the stock market even if there is a major correction. Is there a case for "market timing?"

Market guru Elaine Garzarelli urges investors to get out of the stock market now and come back when stocks are cheap. James Stack, who publishes InvesTech, a market newsletter, notes that an investor who left his money in the stock market after the onset of the 1929 crash did not see market averages restored to pre-1929 levels until the mid-1950s. At least, say the "bears," set up a money market account with any mutual-fund company in which you have large holdings. If market indexes drop 15 to 20 percent and look as if they could plunge further, consider shifting assets to the money fund. Big institutional investors do that. But you must then seek a reentry point into the market when you figure prices are near their bottom.

What about bonds?

Some analysts, such as Eric Miller, chief investment strategist at Donaldson, Lufkin & Jenrette, in New York, hold that bonds will outperform stocks during much of 1997. Interest rates have been holding fairly steady. Inflation remains under control. On the stock side, the growth of corporate earnings is expected to dip this year, as the economy cools.

Which stock sectors look most promising?

Larry Wachtel, a vice president of Prudential Securities Inc., says the technology and energy/natural-resource sectors are showing endurance.

Technology firms are being aided by the continuing business revolution in the United States, as firms, eager to boost productivity and compete internationally, increasingly employ electronic networks.

Meanwhile, global industrial demands continue to spur demand for natural resources, involving, in the US, natural gas and oil service firms.

Mr. Chalasani also likes technology stocks, selected small-capitalization (that is, smaller market value) firms, and some banks and insurance companies.

What is the "January effect?"

In 58 of the past 71 years, small-cap stocks - that is, stocks of smaller companies, many in the technology area - have outpaced larger companies by an average of more than 5 percent in January. This so-called "January effect" actually starts in December and spills into February.

Some forecasters, such as the newsletter Personal Finance, anticipate strong performance by small-cap firms during '97. Small companies have tended to do well under Democratic presidents, who have encouraged fiscal measures to stimulate jobs.

But the Clinton White House is aiming for a balanced budget.

Even if small-cap firms do well in January, they may not do well the rest of the year, given the low tolerance for risk by many investors, Salomon Brothers warns.

Even if individual small-cap stocks do well, that does not guarantee strong gains by small-cap mutual funds. The No-Load Investor, a monthly newsletter, notes that the average small-cap no-load fund lost ground slightly in January of both 1995 1996.

Are there other investments one should not overlook?

Yes. Here are two:

1. Money market funds. Money has been pouring into these accounts in past months as investors have been scrambling for "safety." Taxable money funds are yielding around 5 percent. That pales alongside higher returns in the stock market. But if the market were to correct, that 5 percent might look quite attractive, say contrarians.

2. REITS, real estate investment trusts. "We expect them to do very well in 1997," says Chalasani. These trusts invest in various types of real estate. Their shares can be purchased through brokers or mutual funds. REITs did well in 1996. Everen Securities' real estate stock index posted a total return of more than 20 percent, about the same as the S&P 500. What makes REITs particularly appealing is that in a stock market downturn their shares usually drop less than stock market averages.

Some analysts say bonds will outperform stocks in 1997. Interest rates have been fairly steady; inflation remains under control.

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