Market Indicators - Investor Sentiment: Still Bullish

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This was the 5/1 Barron's cover article:

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Still Bullish

Our exclusive poll's message: Don't count stocks out yet

By Jacqueline Doherty

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The volatility that has plagued the stock markets throughout 2000 continued last week as strong economic reports sent shares tumbling. The Dow Jones Industrial Average is down 6.6% so far this year, and the Nasdaq has lost 5.1%. But don't expect crocodile tears from the 153 participants in our Big Money Poll. A majority of the group remains surprisingly confident that all will turn out well over the next six and 12 months.

"The bears are having their day in the sun right now," says a bullish Erik Gustafson, senior portfolio manager at Stein Roe & Farnham. "But they've been wrong for the past 10 years and they'll be wrong for the next 10 years."

Despite the markets' rockiness, bulls believe the big picture hasn't changed. They still see a strong economy, low inflation, healthy corporate earnings and improvements in productivity. Need more evidence? Respondents point to the peace that blankets most of the earth, a growing worldwide population bolstering demand and increased retirement savings pumping cash into the stock markets. The recent volatility hasn't changed any of these positive macro events. So, say the optimists, the current turmoil is only a correction and not the beginning of a protracted bear market.

"I think people have overreacted," said Thomas Porta, who runs Porta Investment Management in Benicia, California. "I think the market is going to come right back as fast as it came down."

Such cheery sentiment is quite the norm among our respondents. A whopping 58.6% of managers find themselves either bullish or very bullish about the market's fortunes over the next six months. That's well above the 42% who were optimistic last fall and the 38% who were positive about the future a year ago.

The managers' outlooks are a bit less rosy when they ponder the market over the next year. Our survey shows 44.1% are bullish over the next 12 months, which is a bit below the 54% who were last fall and in line with the 45% who were positive last year.....

...."I view this as a correction that was well overdue and a valuation adjustment," says James Weiss, chief investment officer for equities at State Street Research & Management. "I think we're in the process of returning to rates of return on stocks that are closer to the long-run average of 10%."...

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....But battered bears have been granted some relief. For the first time in ages, momentum investors got burned this spring as the Nasdaq plummeted 355.49 points, or 9.67%, on April 14, its worst point drop and second-largest percentage decline ever. The roller-coaster ride obviously hasn't ended. Despite recent market declines, bears still believe stock valuations remain too high and, therefore, the market's correction should continue.

"The length of the decline needs to be longer, with more pain felt," says John Keene, president of Keene & Associates in Fort Worth. "The buy-on-the-dip mentality may have been chipped at a bit or bruised, but it hasn't been eliminated."

In general, the pessimists agree that the recent Nasdaq swoon doesn't qualify as a bear market. Stocks came roaring back too quickly, and the broader market failed to drop in tandem, they maintain. A bear market won't be upon us, they say, until the buy-on-the-dip crowd gets singed by a market bounce that leads only to lower prices later. The process needs to be repeated until the vast majority no longer considers a tumble a buying opportunity.

"To me, a bear market is when investors want to get out of stocks in general. They hit a puke point, and that's when you know you've hit bottom," says A. Gary Shilling, president of A. Gary Shilling & Co. in Springfield, New Jersey.

The actual universe of bears remains quite small -- perhaps a reason for concern in and of itself. In our most recent poll, only 15% of respondents were bearish or very bearish for the next six months. That's well below the 24% who were pessimistic both last fall and a year ago.

Their ranks don't exactly swell when portfolio managers are asked to forecast the atmosphere 12 months ahead. Only 19% of respondents were bearish over a one-year time horizon. That's a bit larger than the 17% who considered themselves bears last fall, but below the 21% who claimed to be long-term bears a year ago.

One of the largest factors dividing those who are upbeat from those who remain dubious is their outlook on the economy. On average, our money managers expect it to stay strong, but see growth slowing slightly from its blistering 5.4% pace of the first quarter. On average, they anticipate GDP gains of 4.54% this year and 3.58% in 2001.

"The macro economy controls the game, and right now the U.S. economy is in the best shape it has been in for a long, long time," says Hugh Taylor of Boston-based Taylor Investment Associates. Such excellent performance can be credited to the end of the Cold War and the lack of a major traditional war in recent years. Our ability to cut defense spending and focus on private-sector spending has helped to propel this bull along, he maintains.

Andrew Ward, a managing director at Moody Lynn & Co. in Boston, remains a long-term bull because he believes an expanding worldwide population will keep consumption -- and therefore demand -- increasing. In the short term, however, he's a bit more cautious. "I think the market is going to have another selloff in May," Ward warns. "The market has run up too fast, and traditionally the market will retest its bottom."

If the economy does slow, it will take some pressure off the Federal Reserve, which exists to worry about inflation. Our seers expected inflation, as measured by the consumer price index, to rise only 2.96% this year and 2.95% in 2001. That's a touch lower than 3.7% rate recorded in March.

Despite the expected slowdown, 98.6% of respondents still believe the Fed will boost rates further this year. When the survey was conducted, most believed a quarter- or half-percentage-point hike would get the job done. But that was before Thursday's employment cost index report noted that wages, salaries and benefits rose by 1.4% in the first quarter, the fastest pace in more than 10 years.

The Fed probably will raise rates to buy some insurance against inflation and to make certain it won't have to act in the months just prior to the presidential election, says State Street's Weiss. He believes inflation has been kept at bay because of technology-driven productivity gains. "The power of productivity is underappreciated in the minds of most economists and investors," Weiss says. Adds Stein Roe's Gustafson: "The notion that runaway inflation is about to break out is fiction. No one can raise prices, Corporate America has made cost cutting a priority, and technology is a deflationary force." He also looks to the markets in gold, commodities, oil and bonds for evidence that inflation isn't about to become a problem. "The markets are telling you inflation is under control."

Although oil has risen from $12 a barrel last year to $24.80 currently, it has come down quite a bit from its high of $33.80, reached in early March. The increase, most managers believe, was only temporary. On average, they expect West Texas crude to cost $26.98 in 2000 and $25.20 next year. So it's no surprise that a convincing 83.8% of our respondents think petro prices won't rise. And that's a good thing because 62.5% of those polled said higher oil prices would hurt the U.S. economy.

The economic scenario laid out by the bears is obviously quite a bit different. John Lumbard, of Lumbard Investment Counseling in Hollis, New Hampshire, expects tech stocks to continue their tumble and to drag down the Dow. A slide in stocks would reverse the wealth effect and could put pressure on the dollar, he says. All of the above, plus Fed tightening, will lead to a recession by next year, argues this bear.

Regardless of what the Fed ultimately does, it might want to note that almost half of our portfolio managers feel that the central bank has become less effective. Asked whether the Fed's ability to affect the economy and the financial markets has been reduced, 50.7% said yes, while 49.3% said no -- a statistical dead heat. While the Fed supervises the money in the banking system, more and more money is flowing outside the system, making it tougher to control, explain those who think that Greenspan & Co. have lost some clout. Individuals keep more of their greenbacks in money-market accounts than in bank accounts. And the capital markets play a larger role in lending money these days. Simply put, banks have become less important to the economy.

"The growth of the stock market has injected a new form of 'money supply' that is outside the direct control of the Fed," one manager reasoned.

Others point out the growing influence of government-sponsored agencies, like Freddie Mac and Fannie Mae, to explain the Fed's diluted power. These agencies have made it easier for individuals to borrow money to buy homes, which boosts the economy. That works in direct opposition to the Fed, which is attempting to slow the economy down.

But don't play taps for the Greenspan gang quite yet. Old Economy companies still borrow, as do consumers, who have been driving much of the nation's economic growth. And eventually, a large group believes, higher rates will have a telling effect. "The Fed still controls short-term interest rates, which are very effective long-term tools," writes one manager. "Investors think [results] happen in Internet time, but the lag effects are nine to 12 months." So while the economy has yet to show clear signs of cooling, Fed believers say it's just a matter of time before we see results.

Once the market believes the Fed is almost or completely finished with boosting interest rates, a number of folks expect the U.S. equity markets to take off. Bulls point to the continued strength of corporate earnings. So far for the first quarter, S&P operating earnings have risen 24%, according to First Call/Thomson Financial. That strong increase is usually found as companies are recovering from a recession. It's not the norm for an economy that has been growing steadily for many years.....

.....Despite the recent volatility, technology shares still seem to have a grip on the hearts and souls of most portfolio managers. When asked which industry sectors will lead the market over the next six to 12 months, 75.7% of the votes came in for technology stocks. "Everybody wants to be at ground level for the next Microsoft, Yahoo or AOL," says Ward of Moody Lynn.

And earnings continue to make tech shares worthy of admiration. So far technology companies in the S&P 500 have reported earnings that are 32% higher than they were last year. That puts them behind only energy companies, whose earnings have jumped 114% in the first quarter, thanks to higher oil prices, and basic materials companies.

So, it should come as no surprise that technology shares are liberally sprinkled throughout our list of money managers' favorite stocks. Cisco Systems crowns the list, followed by Intel, General Electric, Enron, JDS Uniphase and Microsoft.

"There's a global appetite for technology that isn't anywhere near sated," says State Street's Weiss.....

...Adds Porta: "Technology is going to keep on growing. If you have the money to invest, you invest in the companies that have the best growth potential in the future." He maintains his 7000 year-end target for Nasdaq.

Indeed, 22.1% of those participating in the survey felt the divergence between Old and New Economy stocks was permanent. "The New Economy continues to grow much faster than the Old Economy," wrote one participant. "The information revolution will last for several more years, at least." Coming in as the second-most-popular sector were financial shares, with 38.9% of the vote. Health-care shares ranked third. To like financials, one must trust that the economy will slow, which should help interest rates and the bond markets.....

....Ironically, technology also was the sector named by 49.3% of our respondents as the area that will have the weakest showing in the next six to 12 months. Basic materials fell into second place and consumer cyclicals were third.

"Extreme valuations, primarily in technology and telecommunications, would give anyone pause," says Keene of Keene & Associates. "There are simply too many individuals in the market who don't have a true appreciation for risk."

Given these results, perhaps it shouldn't come as a shock that many tech shares were also named as those considered the most overvalued. Cisco Systems, which was ranked as the favorite stock of portfolio managers, also was considered the second-most-overvalued stock by others. Another of the portfolio managers' favorites, JDS Uniphase, makes an appearance near the top of the list of most overvalued stocks as well. Internet companies continue to dominate the overvalued category: Amazon.com captured the top spot, Yahoo was in third place and America Online and eBay weren't far behind in fifth and sixth place, respectively. Amazingly, 14.9% of respondents admitted to owning at least one of the two stocks they felt were the most overvalued.

"Tech valuations are a concern and will lead them to underperform in the next 12 months," says Marvin Burt, president of Burt Associates in Rockville, Maryland, who considers himself neutral on the market. "Investors now see a lot more risk in these stocks" and they want to stick to tech companies that are generating profits.

Despite the love-fest for technology, 77.9% of investors were convinced that the divergence between Old Economy stocks and New Economy stocks was temporary. "The New Economy bubble will burst and investors will perceive that Old Economy stocks will employ New Economy tools," one person wrote. Another noted, "There is only one economy and the so-called Old will adapt and become New or go out of business."...

...62.8% of those surveyed expect small-cap stocks to rally. But they're not quite ready to bet their money on that opinion. On average, managers have 58.4% of their equity funds in large-cap stocks, 23% in midcaps and only 18.6% in small-caps. That allocation hasn't changed much over the past year.....

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Don't ya just hate this description of a bear market:

A bear market won't be upon us, they say, until the buy-on-the-dip crowd gets singed by a market bounce that leads only to lower prices later. The process needs to be repeated until the vast majority no longer considers a tumble a buying opportunity.

"To me, a bear market is when investors want to get out of stocks in general. They hit a puke point, and that's when you know you've hit bottom,"

All together now:

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......Jen

-- posted by JenL_2