The Coming Year: S&P 500 Seen Higher in 1999 but Not as High as Past Few Years

Stocks will rise this year, but the gains will slow, market watchers predict.
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"One for the thumb" could be the motto of stock-market bulls in 1999, following an unprecedented fourth year of 20%-plus gains by the

S&P 500

. Just as the quest for a then-record fifth

Super Bowl

triumph eluded the

Pittsburgh Steelers

, most stock-market prognosticators expect the fifth "ring" to prove unattainable for the S&P.

Then again, few forecasters predicted stocks would perform so well in 1998. (Indeed, the vaunted Super Bowl indicator, which dictated a negative year because of the

AFC

champion

Denver Broncos'

win, failed miserably as a crystal ball.) Moreover, given the recent surge by major proxies (just today, the

Dow

was up more than 200 points), some of the more optimistic prognosticators may already be thinking of ratcheting up their forecasts.

Heading into 1998, Jeffrey Applegate, chief investment strategist at

Lehman Brothers

, predicted the equity market would rise 18%, with growth outperforming value stocks and big-cap outperforming small. He also predicted the 30-year Treasury bond yield would fall to 5.25% and the fed funds rate would be at 5%.

The forecasts proved prescient, if not a tad conservative. Those long stocks might hope for a repeat in the new year. Applegate remains upbeat on prospects for growth stocks, namely blue-chip technology, health care and financials, but the strategist predicts expected total return of "just below" 10% for broad-market proxies in 1999. The strategist predicts the S&P 500 will rise to 1325 in 1999. (This forecast was recently raised from 1250 in mid-December.) Meanwhile, he sees the

Federal Reserve

lowering interest rates another 100 basis points and the long bond rallying to 4.50%

"If we've got it right, the growth and earnings outlook ought to be better in the second half of 1999" as the global economy troughs, Applegate says. From his vantage point, policy makers, not the investing patterns of baby boomers, hold the key to the market's performance in 1999.

"If we had the same demographics but had a dreadful policy mix, you wouldn't want to own stocks," he says. "It's not just here. It's the

European Central Bank

; it's

President

Henrique Fernando

Cardoso

getting it right in Brazil, the

LDP

getting it less wrong in Tokyo and China not devaluing. As we know, they're all linked."

Another longstanding bull, Joseph Battipaglia, chairman of investment policy at

Gruntal

, shares Applegate's view.

"I think the biggest challenge is going to be whether or not China can maintain an even keel in terms of restructuring their economy and keeping up a high level of

trade surplus," Battipaglia says. "In the main, they're our next strategic trading partner, and their financial health is very important."

Nothwithstanding risks in China (and elsewhere), "I think it's going to be another up year," he says. He predicts the Dow Jones Industrial Average will be at 10,000 by midyear and 10,500 by year-end, the S&P 500 at 1250 midyear and 1300 by year-end, the

Nasdaq Composite Index

at 2300 by year-end and the

Russell 2000

enjoying the biggest percentage move of all, up to as high as 525. Given the recent gains -- notably by the Nasdaq -- Battipaglia suggests the forecast "might be a little light."

As far as the shape of the coming year, the investment chair expects the first half of the year to be stronger, as companies increase capital spending in anticipation of the year 2000 bug. "Then in the second half, you'll get a hiccup as everyone gasps as we see what we got," he says. "Alternatively, the second half could be quite explosive when Y2K mania fades and everyone focuses

on the fact that the lights are not going out."

Y2K: The Final Countdown

In their forecasts, most prognosticators address the fear that computers will be unable to recognize the year 2000, disrupting everything from factories to power plants, to banking systems and air-traffic control.

Peter Canelo, U.S. investment strategist at

Morgan Stanley Dean Witter

, says Y2K could impact stock selection beginning in the spring. "By February, we'll have another round of 10Qs and 10Ks with comprehensive disclosure on Y2K," Canelo says. "I think companies that are not ready may be penalized and companies that are will get a boost."

But Y2K will not prevent another up year for the broader market or send the economy into recession, the strategist says.

"Financial systems will operate, the lights will work,

and so will phones and power systems," he says. "If basic infrastructure is operating, you're not going to have recession."

Canelo predicts the S&P 500 will rise 10% to 15%. "I don't think we'll have another year of 20% to 30%, but that's still pretty good," he says. "I think we'll have a positive surprise on the economy, which is not going to slow as much as people think. Also we'll have very good retail activity -- consumer delinquency on debt is coming down, contrary to the talk about negative savings, which I don't think is true."

The new millennium is a bigger concern for Alan Skrainka, chief market strategist at

Edward Jones

in St. Louis. "If we have a swoon next year, it could be related to hysteria that could result from the Y2K problem," Skrainka says. "A lot of people that are shrugging it off today may get caught up in the frenzy as we get closer, much like they got caught up in the Asian crises" in 1998.

Skrainka says a 7% rise is a "fair expectation for the appreciation of the market" next year, noting that "trying to lower expectations after four-plus years of 20% growth" is a big concern.

Lose the Rose-Colored Glasses

Skrainka's fair expectation is 100 basis points beyond "the most optimistic expected return" of Richard Bernstein, chief quantitative strategist at

Merrill Lynch

.

"We're in a profits recession, and I think over the next several months, we'll see earnings continue to erode and the Fed not providing an immense amount of liquidity," Bernstein says. "That's not a real good combination."

The probability of stocks being the best-performing asset class in 1999 is "extremely low," he says. "If you think earnings are going to continue to erode, you have to shield yourself. Head toward stable growth companies, consumer staples, utilities, insurance companies and life insurance. Stay away from basic industries, capital equipment and certain areas of technology."

Although most tech firms boast relatively high growth rates, the group has "the most foreign exposure" of any U.S. industry, Bernstein notes. "It's no accident the tech stocks have come back when some Asian markets came back to life," he says. "If we're correct and we're going into a deeper profits recession, that will hurt capital spending. The problem is there's still a cycle."

Rest of the Best

Because of space and time constraints, we're unable to divulge the views of all the top market prognosticators. Here, then, is a snapshot of forecasts, culled either from direct conversations or, where noted, written reports.

Abby Joseph Cohen

, market strategist,

Goldman Sachs

, in

1999: Issues and Outlooks

, published Dec. 14: "Supertanker America continues to move ahead despite turbulent global conditions. Averages mislead and we expect notable disparities by sector in economic, profit and stock price performance in 1999. Nonetheless, S&P 500 operating earnings are likely to grow 5% to 7% and the index to reach 1275 by year-end 1999. The rough equivalent for the

Dow is 9850."

Ralph Acampora

, chief technical analyst at

Prudential Securities

, in

Our Outlook for the Stock Market in 1999 -- The Year of the Stock Picker

, published Dec. 11: "Sudden and very nasty declines (corrections, interruptions, call them what you will) should mark the coming year. The Dow Jones Industrial Average should meander somewhere between a low range of 7800 to 8450 and high range of 9800 to 11,500. Comparable levels for the S&P Composite are 1050 to 1090 on the low side and 1350 to 1525 on the high side."

Edward Kerschner

, chairman, investment policy committee,

PaineWebber

, in

1999 Outlook: New Highs -- Yes; Big Gains -- No

, published Dec. 1: "Stocks look modestly attractive bogeyed against bonds, a bit vulnerable bogeyed versus short-term rates; fairly valued on a P/E basis. Liquidity is modestly positive; earnings power slightly negative. 1999 'normal' values 1250 S&P 500; 9750 Dow."

Courtney Smith

, chief investment officer,

Orbitex Management

: "I think the key to 1999 is liquidity and Fed policy

and Fed policy will be bullish. Also, we've come through the best year ever for

mergers and acquisitions, reducing the supply of large-cap stocks. I would hesitate to say we'll get 20%

gains because it's unlikely we'll expand P/Es more, but 10% seems very doable. We still have a bullish underlying feature."

David Klassen

, head of U.S. equities,

Chase Asset Management

: "Big-caps, the stuff that's been working recently, works through January and lifts the big average to around 9400 to 9500 because of momentum and cash flows. Sometime in the first quarter, investors will move out on the risk spectrum, out of multinationals and down the capitalization curve. Expect strength in the Dow and S&P to be in early in the year

but expect small- and mid-cap to outperform by 2 to 1."

Philip Roth

, chief technical analyst, Morgan Stanley Dean Witter: "I think the market doesn't have a lot of upside. We've had four years in a row of gains well above the norm, and I think investors should assume we will revert to the mean. The historic average is 10% or 11%; investors should expect less than that average. It's too early to say we'll have a down year, but if we start very poor and January is a bad month, then I'd say 1999 will be a bad year."

Robin Griffiths

, chief technical analyst,

HSBC James Capel

: "I see no sign the great public of America is saying 'P/Es are too high, I think I'll sell my shares.' The risk is I've undercalled it and instead of going to 10,500

the Dow melts up to 11,500 or 12,000 and then you have

Alan Greenspan

talking about irrational exuberance and trying to cool it off by raising rates."