Wall Street Sees Silver Lining in Health Care Storm
From Wall Street’s point of view, the early line on President Clinton’s health care reform package is this: It’s way too early to worry about the potential negative effects.
In the meantime, the outlook for corporate earnings, interest rates and inflation strongly suggests that stock prices still have plenty of upside left this year and into 1994.
The market responded to Clinton’s health care speech Wednesday night with a broad rally on Thursday. You didn’t see it in the Dow industrials, which slipped 7.27 points to 3,539.75. But most stock indexes closed higher, and winners topped losers 11 to 9 on the New York Stock Exchange.
More important, the Nasdaq composite index of 4,000 mostly smaller stocks soared 6.72 points to an all-time high of 752.26. The Dow, meanwhile, is languishing 3% below its peak of 3,652.09 reached Aug. 25.
Many market pros believe the Dow index’s recent problems have little to do with the specter of higher business costs under health care reform, or even with Russia’s latest crisis. Instead, investors are focused on corporate earnings growth--as in, who’s got it now and who doesn’t.
In the current quarter, which ends next Thursday, the fear is that many big industrial firms that operate worldwide could post lower than expected earnings because of the continuing recessions in Europe and Japan. Hence, stocks such as Alcoa, International Paper and IBM have pulled the Dow down this month.
“Where the Dow is vulnerable to an earnings surprise is in the export side of the businesses,” says J. Richard Walton, strategist at Wertheim Schroder Investment Services in New York.
In addition, the Clinton budget bill signed last month increases the corporate income tax rate retroactively for all of 1993 to 35% from 34%. That will cause a bigger bite in taxes in the current quarter, says Abby Cohen, investment strategist at Goldman, Sachs & Co. in New York. As a result, “investors may experience an increased number of negative earnings surprises in the upcoming weeks,” she warns.
But the usual pattern after each quarter is that the earnings disappointments get the early headlines, while results overall look pretty healthy when all is said and done.
Indeed, most companies still are expected to post decent year-over-year earnings gains this quarter, thanks to the U.S. economy’s moderate growth, widespread corporate cost cutting and the huge drop in borrowing costs since last fall. Melissa Brown, who tracks earnings for Prudential Securities in New York, says the large universe of stocks her firm follows should show a 24% average rise in earnings this quarter.
What about health care reform? Clearly it’s going to cost some companies more to insure their workers if the Clinton plan becomes law. But those costs are too far off and too nebulous for Wall Street to make any sense of them. “Any plan probably won’t be implemented earlier than 1995,” Walton says, “so the market isn’t going to worry about the impact on earnings yet.”
In the meantime, he says, the pressure for health care reform could actually have a beneficial effect on financial markets: By adding new momentum to the drive to lower medical costs, Clinton’s proposals could force health care providers, drug makers and other players to accelerate efforts to reduce prices, or at least slow the rate of increase.
That would help keep inflation down, providing a good backdrop for lower or stable interest rates--which in turn should help keep the stock bull market on its feet.
And the stocks that would benefit most in a moderate-growth, low-inflation environment are the same ones that have led this bull market since 1990, experts say: shares of lean and nimble smaller companies, which in the aggregate are enjoying better earnings growth than blue-chips.
That’s why the Nasdaq index is at a new high while the Dow lags. “To find growth in this economy, investors have to move down the (company) size curve,” argues Bill Nasgovitz of the Milwaukee-based Heartland Value small-stock fund, which is up 12% so far in 1993.
Jack LaPorte, manager of the T. Rowe Price New Horizons stock fund in Baltimore, notes that smaller stocks are beating blue-chips for a third straight year. (The Nasdaq composite is up 11% year-to-date; the Dow is up 7%.) By now, he says, investors should realize that the smaller stocks’ superior performance is a trend, not a fluke.
The last big earnings-driven bull market in small stocks lasted from 1976 to 1983, LaPorte says. If this one lasts that long, it has four years left to run.
What Buyers Want
Some of the Nasdaq stocks up sharply Thursday and this year, as investors hunt for strong earnings growth in a slow-growing economy:
Thurs. close Change Stock and change yr. to date Qualcomm 80 1/4, +1 5/8 +231% IDB Communications 52 3/4, +2 1/4 +145% Oracle Systems 59 1/4, + 5/8 +109% Advanta 60 1/8, +4 7/8 +86% HBO 37, + 1/2 +44% Sybase 66 1/2, +3 7/8 +35% Oxford Health 73 3/4, +4 +31% Cheesecake Factory 29 1/8, +2 5/8 +21%
All stocks trade on Nasdaq.
