Whither the Dow Analysts forecast slight improvement, with no big swings

January 03, 1993|By Ian Johnson | Ian Johnson,New York Bureau

NEW YORK — New York--As the economy twitched and jerked over the past two years, investors watched with puzzlement -- and pleasure -- as the stock market somehow moved to record highs.

So now that a stronger economic recovery is building, investors can expect further market records in 1993, right? Wrong, of course.

As with all things economic, there's a downside to "good" news. Behind economic growth lurks the dark force of inflation, and higher interest rates are likely to produce investments safer than the stock market. And that means lower stock values.

So the market will crash this year, right? Wrong again. Economic growth probably won't be so bad for the market. With growth, most companies will post higher earnings and will maintain or increase dividends. And that means higher stock values.

The result of this battle between investment strategies and economic fundamentals: a flat or down market in 1993. Although some investment firms have radically different forecasts, most expect the Dow Jones industrial average to improve slightly. The market could set new highs early on and suffer a 10 percent correction by midyear, but few market strategists expect a dramatic bear or bull market.

"We haven't got the profits or the economic growth to support strong gains. The primary force behind the stock market right now is interest rates, and they will not go down any further," said David Shulman, equity strategist for Salomon Brothers Inc. He forecasts single-digit returns from stocks in 1993.

Interest rates have been driven by the Federal Reserve, which last summer cut the discount rate from 3.5 to 3 percent, the lowest level in nearly three decades. The Fed's theory: cheap money would boost the economy, whose recovery had stalled.

A side effect, however, was to make the interest earned on bank deposits barely higher than the 3 percent inflation rate. This forced small investors into stocks and sustained the stock market's modest rally.

Since October, after fears about the election eased, the Dow has risen 140 points to close Thursday, New Year's Eve, at 3301.11.

As the economy gains momentum, few see the Fed cutting rates further. In fact, the Fed could turn its attention toward battling inflation in the second half of 1993, according to many economists, including Paul Boltz, chief economist at Baltimore-based T. Rowe Price Associates Inc.

Inflation should average 3.2 percent this year, according to a poll of 51 economists in brokerages, industry and universities by Blue Chip Economic Indicators. That's low, but the Fed has indicated that it will move aggressively to prevent any renewal of inflation.

This year, rates aren't likely to climb to levels that would seriously damage the stock market. But as rates rise, and investors put more money in certificates of deposit, money market funds and other interest-bearing investments, the flow of private savings into equities could slow, said David K. McHugh, senior investment counselor at Chicago's the Northern Trust Co.

"It's not uncommon for the stock market to correct itself every three to four years. It would not be a major surprise to us to see a downside in 1993," he said.

Besides interest rates, there's another drag on the market: Stocks are more expensive than ever.

"I'm very cautious on the stock market. It's awfully expensive. Plus, all the small investors are jumping in, and when they come in it usually means the market is near the top," said A. Gary Shilling, who heads a New Jersey research firm that bears his name.

A Salomon Brothers study, for example, shows that the average wage earner would need to work a record 36 hours to buy one $440 unit of the S&P 500 index, a standard measure of the stock market. Two years ago, the same worker had to spend 25 hours to get that sliver of the market.

With prices so high, investors must choose stocks carefully in 1993, instead of relying on lucky picks that follow the market up, analysts warn.

Possible winners: autos, airlines, steel and machinery and other industrial sectors, says I/B/E/S, which tracks analysts' recommendations. Industries out of favor include energy, utilities and consumer nondurable products, such as foods, beverages, tobacco and drugs.

One of the most optimistic market forecasters is Allen Sinai, chief economist at the Boston Company of Economic Advisors. His predictions: Inflation will stay under 3 percent, the Fed may cut interest rates further and the Dow Jones industrial average will hit 3,900.

"The equity market has moved into a new bull market phase," Mr. Sinai said.

Other analysts are more reserved, while remaining optimistic. Byron R. Wien at Morgan Stanley Group Inc. said that in comparison to the woes in Europe and Japan, the United States is poised for a steady, if unspectacular expansion. The Dow should end at about 3,500, he says.

"The early part of the year should be the best period for equity investors. By midyear, when the enormous economic and financial problems accumulated during the past decade begin to weigh heavily on the enthusiasm of the administration and the American public, the performance of common stocks may become more sluggish," Mr. Wien said.

Michael Sherman, chief economist at Shearson Lehman Brothers Inc., worries about a downturn. He has reduced his equity allocation from 55 to 50 percent, adding the difference to long-term bonds. The market could rise if everything goes right, but the chances of a 10 to 15 percent drop are too real to ignore, he says.

"It doesn't preclude a phase where the market sets a new high, but it wouldn't stay there," Mr. Sherman said. "These highs are exceptions that one might, if you were an optimist, believe in."


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