Two Bulls and a Bear on 2006

This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.

The New York Sun
NY Sun
NEW YORK SUN CONTRIBUTOR

Here we go again. The bevy of year-end forecasts that purport to tell us where the stock market is headed in the year ahead are starting to pepper Wall Street.


Though most such predictions are invariably wrong and often excessively bullish, it’s still smart to know what the big brokerage guns are thinking and advising their clients to do.


In this context, here’s the outlook of three prominent Wall Street strategists, two of whom are bullish, one resoundingly so, and a third who sees 2006 as a do-nothing market.


One bull is Morgan Stanley strategist Henry McVey, who says, “We may have moved too far too fast in recent weeks, but we now believe 2006 will be the year to get long and in size.”


Mr. McVey projects nearly a 12% return in the S&P 500, which he figures should rise to 1,400 at year-end 2006 from his anticipated 2005 close of 1,275. The index closed Friday at 1,259. Driving his sunny outlook are three assumptions:


* The Fed ends its tightening campaign by mid-2006, which will allow valuations to widen.


* Oil trades between $50 and $60 a barrel, which means both inflation and recession expectations are paper tigers.


* Job growth powers along.


Consistent with Mr. McVey’s bullish forecast, he thinks corporations will begin to open their wallets to invest in their businesses via capital expenditures and acquisitions. Further, he notes a slowdown in real estate prices which is happening – that could make stocks look more attractive.


He’s gung-ho on companies with significant pricing power that he thinks should flourish next year, while those without it will be challenged. In this vein, he recommends four pricing power plays: Starwood Hotels, Union Pacific,AIG, and Williams Cos. All four operate in industries currently characterized by tight supply and strong demand.


Mr. McVey also likes companies with free cash growth of at least 10%, rising return on equity, and a rising payout ratio. His ideas from this framework include KLA-Tencor, Harrah’s Entertainment, Cytyc Corporation, and EMC Corporation. As for those companies achieving rising returns on equity, he favors Merrill Lynch, Honeywell, Baxter International, and Marsh & McLennan.


His bullish outlook, Mr. McVey points out, is not without risk. For starters, the incoming chairman of the Federal Reserve, Ben Bernanke, could stifle any rally if he indicates shortterm rates need to move meaningfully higher. A more ominous risk, he notes, is that job growth dwindles, housing rolls over, and credit deteriorates. Yet other worrisome issues include the impact of further adverse GM developments or a breakout of avian flu.


Our raging bull is the chief investment strategist of the Prudential Equity Group, Ed Keon, who’s predicting the S&P 500 will jump 1,530 next year, roughly a 20% increase from current levels. Surprisingly, he expects that 20% gain on 2006 earnings growth of just 6%. So how does he figure such a strong market showing? His scenario: a big drop in inflation, which would boost valuations and lead to multiple expansion. Likewise, he says, if there’s increased participation from retail investors in the equity markets, it would help encourage the Fed to stop boosting rates and move back to the sidelines.


As of now, the public is indeed participating by sustaining its buying binge of the past couple of months. In the last two weeks alone, it poured about $8.4 billion into stock mutual funds.


Mr. Keon says if all of his “ifs” occur, including avoiding a bird flu pandemic and other shocks, “We could have a very good year.” Meanwhile, he’s recommending 100% investment in equities and is tilting toward large-cap growth stocks.


The outlooks from these two bulls sound pretty good, but our bear, a Merrill Lynch strategist,Richard Bernstein, says his “sell side indicator” – his most reliable market timing barometer and one he views as far superior to many widely accepted stock market indicators – suggests investors should be raising cash because we’re in for a flat stock market over the next 12 months.


This indicator, which is a contrary indicator based on a survey of Wall Street strategists’ recommended asset locations, historically has flashed a bullish signal when Wall Street was extremely bearish, and vice versa. Its latest reading is 64.9%, which is up from last month’s 64.6%. Any reading at or above 63.2% generates a sell signal, whereas at or below 50.9% spurs a buy signal. Last month was the first month the indicator moved from neutral to sell since late 1999.


To Mr. Bernstein, the sell side indicator suggests a total return in the S&P 500 of 0% over the next 12 months. Factor in the S&P’s current dividend yield of about 2%, and that implies, he says, a 12-month loss of about 2%. Accordingly, he believes raising cash is the prudent investor strategy.

NY Sun
NEW YORK SUN CONTRIBUTOR

This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.


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