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Monday June 07, 02:44
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U.S. Stocks May Fall Even as Economy, Earnings Grow, Bears Say
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U.S. stocks have dropped the past four months amid the biggest quarterly rise in corporate profits in a decade and projections of the fastest economic growth in 20 years. To investors such as Comstock Partners Inc.’s Charles Minter, the declines are just getting started.
Minter, whose $105 million Comstock Capital Value Fund has beaten the Standard & Poor’s 500 Index in the past five years, said he looks at U.S. stocks today and sees Japan’s market a decade ago -- before the country’s benchmark indexes rallied twice and then slumped to two-decade lows.
Some investors may view the S&P 500’s 3 percent slide since Feb. 11 as ``nothing more than a correction in the next bull market,’’ he said. ``We think we’re in a bear market that will take us to 600,’’ down from Friday’s close of 1122.50.
Investors such as Minter and Robert Arnott, manager of the $2.6 billion Pimco All Asset Fund, said stocks are too expensive relative to profit, and concerns about higher interest rates and slower earnings growth are too prevalent to justify gains.
Shares of companies such as General Electric Co. and Honeywell International Inc., which ought to benefit from a growing economy, are little changed. The Dow Jones Industrial Average has slipped 2 percent for 2004, and the S&P 500 has gained 1 percent.
Last week, the S&P 500 advanced 0.2 percent and the Dow average added 0.5 percent. The Nasdaq Composite Index dropped 0.4 percent.
Rising Profit
The S&P 500’s members will increase second-quarter profit by 19.5 percent, according to the average forecast of analysts surveyed by Thomson Financial. H&R Block Inc., the largest tax preparer, and chipmaker National Semiconductor Corp. are the only two reporting quarterly results this week.
Profit growth may actually reach 25 percent because companies always exceed estimates as a group, according to Thomson. Earnings grew by 28 percent, the most in a decade, in the fourth quarter of 2003 and by 27.5 percent during the first three months of this year.
The economy may expand this year by 4.6 percent, the fastest rate since 1984, according to a median forecast of 56 economists surveyed by Bloomberg News on April 27-30.
In May, the economy added 248,000 jobs amid the biggest gain in manufacturing employment in almost six years, a Labor Department report showed Friday. The overall increase recouped the last of the jobs lost since November 2001, when the economy came out of recession.
What’s Wrong?
``The economy and corporate earnings cycle are in excellent shape,’’ said Philip Orlando, who manages the $300 million Federated Large Cap Growth Fund and predicts the S&P will close the year at 1200.
So what’s bugging the market? Plenty, according to Richard Bernstein, Wall Street’s top quantitative market analyst last year as judged by money managers in an Institutional Investor magazine survey.
``As we go through 2004, the Federal Reserve is probably going to tighten,’’ or raise interest rates, said Bernstein, Merrill Lynch & Co.’s chief U.S. strategist. ``Profits will decelerate. There’s the nagging issue of oil prices.’’
The Fed’s Open Market Committee meets on June 29-30 and will weigh whether to change its benchmark rate from a four-decade low of 1 percent. July federal funds futures contracts yield 1.25 percent, suggesting traders see a 100 percent chance the Fed will raise its target rate for overnight loans between banks by a quarter point at the meeting.
`Widespread Myth’
Profit growth will slow to 13.5 percent in the third quarter and 15 percent in the last three months of the year, according to Thomson.
Crude-oil futures have climbed 28 percent in the past year, reaching $42.33 a barrel Tuesday, the highest close since the contracts started trading in 1983. Oil for July delivery declined the past three days to end the week at $38.49.
Rising oil prices mean higher energy costs for companies and consumers alike, reducing what they can afford to spend on other goods and services.
Arnott, founder of Research Affiliates LLC in Pasadena, California, said the ``robust rally’’ in stocks since March 2003 shows investors foresaw the current pace of economic and profit growth. The S&P 500 gained 45 percent from March 11, 2003, when it reached last year’s low, to its 2004 high on Feb. 11.
``There is a widespread myth that earnings drive the market,’’ he said. ``It’s quite the opposite. The market anticipates the earnings.’’
Avoiding Extremes
Some of the biggest companies are little changed for the year. General Electric, the world’s most valuable company, has risen 0.8 percent and Honeywell, the largest maker of airplane- cockpit equipment, has added 0.9 percent. Verizon Communications Inc., the No. 1 U.S. provider of local-telephone service, has dropped 0.3 percent.
Robert Doll Jr., president of Merrill Lynch Investment Managers, said the stock market will avoid extremes. Indexes may swing between the highs of 2000 and the depths of 2002, he said. The S&P 500 peaked at 1527.46 and hit bottom at 776.76.
``The lows we saw in October 2002 may have been very important,’’ said Doll, whose firm oversees $513 billion in Plainsboro, New Jersey. ``We might not make a new high, but I’m not sure we’re going to make a new low. Maybe we’ve defined a bottom and a top.’’
Minter said stocks are headed lower even if there are further rallies, as happened in Japan. The Nikkei 225 Stock Average rose from mid-1995 to mid-1996, and again in 1999 and 2000, only to plunge from 2000 to 2003. The benchmark touched bottom last year at 7607.88, 80 percent below its peak in 1989.
Cutting Stocks
Arnott said the S&P 500 should be valued at 700 to 800 based on what the benchmark members earn and pay in dividends,
``I don’t expect stocks to be higher, in inflation-adjusted terms, 15 years from now than they are today,’’ he said.
Pimco All Asset, his mutual fund, has half its money in investments that may benefit from accelerating inflation, such as real estate stocks, inflation-indexed bonds and commodities. Other stock holdings account for 25 percent of assets, a drop from 35 percent late last year.
The growth in earnings and the economy are so well known that they’re already reflected in stock prices, he said. Stocks began their climb last year just as concern for the economy and events such as the war in Iraq reached a crescendo, he said.
``You’re off to the races when nobody thinks you are,’’ Arnott said.
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