With 2005 fast approaching, Wall Street analysts are once again gazing into their crystal balls. What they see is a dull but mildly positive year for stocks.
Although strategists are calling for higher interest rates and a weaker pace of earnings growth next year, they believe stocks will inch up as the economy continues to grow at a respectable pace.
The median forecast among the major brokerages is for a 4% increase in the
, although estimates range from a decline of 4.6% to a gain of 10%.
One of last year's most accurate prognosticators, Tom McManus of Banc of America, is actually among the more bearish pundits this year, saying the market could remain flat or fall slightly over the next 12 months.
"We continue to believe that stocks remain a riskier bet in 2005 than in the recent past," he said. "While both earnings and
price-earnings multiples have improved from 2002-2003 levels, stocks have significantly outpaced their long-term performance trend."
McManus worries that inflation will escalate next year and that rising interest rates will trigger a "consumer downshift."
While inflation has remained tame in 2004, price pressures are starting to show up at the wholesale level, and some analysts fear that higher consumer prices will follow.
Retailers and auto companies have attracted buyers this year with aggressive discounts and incentives. But some say these offers are unsustainable in light of rising interest rates and high energy costs.
If prices do go up and the
raises rates as much as analysts expect next year, consumer spending could potentially falter, particularly given the low savings rate, high debt levels and lack of fiscal relief. Rates are expected to climb to between 3.25% and 3.5% by the end of 2005 from 2.25% currently.
Gary Gordon, market strategist at UBS Investment Research, said he expects consumer discretionary spending to come under pressure for several years as debt growth slows.
What's more, he is concerned about high corporate debt levels and a record trade deficit that he thinks will only get worse as China continues to export cheap goods. China's currency is currently pegged to the dollar.
Gordon said corporate profits are likely to disappoint in 2005, which is why he is calling for a 4.6% decline in stocks.
Over at Prudential Securities, quantitative research director Ed Keon has worries of his own. "I still think there is a 10% to 20% chance of a global financial crisis in 2005," he said.
Keon believes that a crash in the dollar or sharp retrenchment in consumer demand is possible, given the massive current account deficit and low personal savings rate. "But ... I think there's at least an 80% chance that we will continue to muddle through," he said.
In fact, Keon thinks stocks will post low-single-digit returns next year as the falling dollar boosts corporate earnings. A 10% decline in the dollar increases sales by about 3% and profits by about 4%, he said, adding that he is expecting "organic" earnings growth of 1% to 2% and dollar-created growth of 3%.
Industry analysts surveyed by Thomson First Call predict that profits will grow by 10.6% next year, after rising 20% in 2004.
Abby Joseph Cohen, the Goldman Sachs analyst who has been bullish for the past decade, is again one of the biggest optimists this year, calling for the S&P 500 to climb 10%.
"We expect U.S. economic and profit growth to decelerate but certainly not end in 2005," she said. "The projected increases in inflation and interest rates will not prevent further gains in U.S. shares."
Cohen expects the economy to grow by 3.4% next year, down from an estimated 4.4% this year. She is also looking for S&P earnings to rise 5%, or slightly more if the Financial Accounting Standards Board defers the expensing of stock options.
Smith Barney's chief investment strategist, Tobias Levkovich, who actually called for stocks to decline in 2004, said lower oil prices and better-than-expected earnings could support the market in the year ahead.
"Modest productivity gains could sustain some additional, albeit slight, margin improvement," he said. "Furthermore, weaker energy prices ... should bolster consumer spending capacity and global GDP growth potential."
Morgan Stanley analyst Henry McVey agrees that stocks should move higher next year, but he believes the first half of the year will be better than the second half.
"The greenback's effect on inflation and, more importantly, rates could cap returns in the second half," he said, adding that value stocks probably will outperform growth.
At Merrill Lynch, quantitative strategist Richard Bernstein is looking for a 3% to 5% gain in the S&P 500, based on projected economic growth of 3%. But he believes the technical and fundamental backdrop is deteriorating.
"The current bull market is already two years old and, while there could be some further strength in the early part of the year, investors should look out for evidence of a subsequent cyclical top," he said.
Bernstein thinks the market is embarking on a long corrective phase similar to that seen from 1968 to 1982. "If this happens, cyclical market- timing and proper sector and group selection will increase in importance," he said.
Although Bernstein called for stocks to fall in 2004, analysts' predictions were surprisingly accurate on the whole. At the start of the year, the median gain for the S&P 500 was projected to be around 7%. With just a few days left in the year, the S&P is up 8.4%, at 1205.