Modest rise in stocks forecast

Pleased with '06 gains, experts optimistic but cautious on '07 outlook

Analysis

January 02, 2007|By Tom Petruno | Tom Petruno,Los Angeles Times

Many professional investors' stock market forecasts for 2007 follow a time-honored strategy: Restrain your expectations and you're less likely to be disappointed.

The typical outlook of money managers and market strategists is for a high-single-digit percentage gain in U.S. blue-chip stocks, weaker returns on small-company stocks, and a general hankering for higher-quality investments over riskier ones.

Yes indeed, you've heard this all before. A year ago, in fact.

Those restrained expectations for 2006 were comfortably exceeded, for the most part. Instead of a single-digit return, the blue-chip Standard & Poor's 500 index gained about 16 percent this year, including dividends.

Smaller stocks? The Russell 2000 index of that universe produced a return of more than 18 percent for the year, beating blue chips.

Higher quality investments over riskier ones? For sure, it was a good year to stay away from Saudi Arabian stocks, which fell 52 percent. But that was the exception in another stellar year for emerging markets. The average emerging-market stock mutual fund soared more than 31 percent, Lipper Inc. says

The consensus forecasts for 2006 were wrong, but few investors are likely to complain. The rising tide lifted all boats, although some were lifted higher than others.

Given the results of 2006, those on Wall Street who make their living predicting market moves have no reason to venture too far out on the optimism scale for the new year. Why not just play it safe, and hope to be pleasantly surprised again?

Hence, the average price gain predicted for the S&P 500 in 2007 is 8.4 percent, according to a Bloomberg News survey of investment strategists at 14 major brokerages.

That sounds good to Sam Stovall, strategist at Standard & Poor's in New York. It's almost exactly his prediction as well."Soft and sweet," he calls the forecast.

But he admits that taking a stance away from the majority view will be tempting for some investors who don't like to be in a crowd, especially a relatively boring crowd.

That could mean betting that stocks fall instead of rise - or that it's time to go for broke, betting on a wild rally that blows out all the stops.

Jason Trennert, who maps strategy for Wall Street research firm Strategas Research Partners, likes the wild-rally scenario. Fear of losing money in stocks, he said, has kept many U.S. investors too cautious since 2002, when the current market upturn began. But the natural progression of a bull market, he said, is "fear giving way to greed."

It's easy to argue that that already has happened in many foreign markets. Is the U.S. next?

"I think the higher-octane stuff, the riskier assets are going to be the best performers" in 2007, Trennert said, mentioning biotechnology and software as two potential standout sectors.

Closer to the other end of the sentiment spectrum is James Stack, the veteran editor of the InvesTech Research investment newsletter in Whitefish, Mont.

Most investors have grown dangerously complacent, he said, precisely because there have been so few significant interruptions in the steady upward trend in share prices since 2002. Complacency is an invitation to disappointment.

He also believes that the Federal Reserve is right to keep warning that inflation pressures are simmering in the economy.

"The biggest surprise that could upset the apple cart," Stack said, "is if the Fed has to return to tightening credit."

Yet for now, Stack agrees that there are no significant signs that the bull market is ending.

That's also one reason why so many professional investors find it comfortable to stay in the middle ground, expecting that, at worst, the U.S. market muddles through with single-digit returns in 2007. The common refrain to stick with higher-quality stocks is the crowd's nod to the risk of jarring potholes along the way: Better to ride in something that would be better able to withstand some shocks.

The No. 1 reason to stay bullish is that the optimistic economic assumption still appears to be intact - which is that the U.S. is in the midst of a "soft landing" of weaker growth that might slow corporate earnings gains for a time but won't halt them. The upside of the soft landing is that it should restrain inflation and set the stage for a period of faster growth in 2008 and beyond.

It isn't as if the bulls are just making this stuff up. A soft landing is what the U.S. economy experienced in the mid-1980s and again in the mid-1990s.

In the late '80s and late '90s, the economic soft landings gave way to stock market advances that far exceeded what most people thought were possible.

Tom Petruno writes for the Los Angeles Times.

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