Wall St. Faces Skeptics
Stock investors made money for a second year in a row in 2004, as every major U.S. market index advanced.
Looking back five years, however, many people may find that their equity portfolios haven’t yet made a dime in this decade. And some analysts contend that the next five years will be just as disappointing.
Indeed, the most heated debate among Wall Street pros these days is whether stocks’ two-year rebound is the start of a sustainable bull market or merely a short-term bounce in an extended decline.
It isn’t just an academic question: Millions of Americans who are saving for retirement, college expenses and other needs are counting on rising share prices over the next five to 10 years.
What’s more, President Bush’s plan to partially privatize Social Security may hinge on whether the stock market stays healthy.
Public support is considered crucial for any proposal that would tamper with Social Security. Without rising stock prices, “that would be the end of it,” Barry Ritholtz, market strategist at brokerage Maxim Group in New York said of Bush’s plan.
It has become an article of faith for Americans that equities are the best place to invest money for the long haul. That was reinforced in the 1980s and 1990s as stocks rose with relatively few interruptions. The blue-chip Standard & Poor’s 500 index produced an average annualized return of 17.9% during those two decades.
But some market pessimists say those results were so good, they in effect stole returns from the future. The prices stocks hit in the 1990s, in other words, already reflected their potential well into the current decade, according to this view.
Steve Hochberg, chief analyst at Elliott Wave International, a Gainesville, Ga.-based financial advisor, contends that the market’s dive from 2000 through 2002 -- when the S&P; 500 plunged 49%, the worst decline since the Great Depression -- was the beginning of a long period of poor or negative results from U.S. shares.
The partial rebound in prices in 2003 and 2004 just revived the main argument against stocks, Hochberg said: They’re too expensive relative to companies’ underlying earnings and given the risks facing the market and the economy.
The average S&P; 500 issue sells for about 18 times estimated 2004 operating earnings per share, according to Standard & Poor’s in New York. Operating earnings exclude one-time gains or losses.
Shares were much more expensive at the market’s peak in early 2000. Viewed historically, however, “stock valuations are too high” again, Hochberg said. “Bull markets just don’t start from these levels.”
Wall Street’s continuing recovery last year reflected the strong U.S. economy and robust corporate earnings, analysts say. Tax cuts on dividend income and capital gains also have helped boost stocks’ appeal; so have relatively low interest rates.
Yet the market faces a number of serious risks that ought to make investors wary of paying higher prices for shares, bearish analysts say.
The Federal Reserve, which began raising short-term interest rates in June, is expected to continue tightening credit this year. That poses a threat to economic growth and to corporate earnings, and provides competition for stocks in the form of higher yields on bonds and bank savings accounts.
Another worry is that the dollar’s continuing slide -- caused at least in part by the huge U.S. budget and trade deficits -- could trigger an exodus of foreign investors from U.S. assets.
And then there are the wild cards of terrorism and a potentially worsening situation in Iraq.
Although Hochberg is among the most pessimistic market pros, and has been for years, the longer-term forecasts of some mainstream analysts also paint a picture of a market that could struggle to eke out gains between now and the end of the decade.
At brokerage Merrill Lynch & Co., Chief Market Analyst Richard McCabe in New York is warning clients that the Dow Jones industrial average might at best reach 11,500 by 2010.
The Dow ended Friday at 10,783.01, up 3.2% for the year after a 25.3% advance in 2003. If McCabe’s forecast is on track, it would mean a mere 6.6% total price increase over five years for someone buying now.
If the market foils his prediction, it is more likely to be because share prices slump rather than soar to new heights, McCabe said. “If I had to pick between a big up surprise or a big down surprise for the market, I’d go with the latter,” he said.
Brian J. Gladish, a 56-year-old software engineer from Long Beach, says he has been worried for a long time that the government’s willingness to run up the budget and trade deficits would eventually trigger a crisis that would be ruinous for the U.S. stock market.
Most of his investments, he said, are limited to gold-mining stocks and foreign shares.
“I think we’re in trouble with our economy,” Gladish said. He has built up cash savings, but says he is “very nervous about allocating it to anything.”
By contrast, many Americans believe stocks will continue to produce handsome gains. The average expected portfolio return over the next 12 months is 11.2%, according to a December survey of 800 investors by brokerage UBS in New York. And 69% of those surveyed said they expected to achieve their investment targets during the next five years.
“One of the things a long bull market does is make people believe they’re entitled,” said John Bollinger, head of Bollinger Capital Management in Manhattan Beach.
Like McCabe, Bollinger expects gains in major market indexes to be sub-par for an extended period. He thinks investors would react to weaker returns by gradually losing interest in stocks.
The sober outlook has history on its side: Long cycles of soaring share prices typically have been followed by long bouts of poor results.
For example, the Dow index rocketed from 175 in 1949 to nearly 1,000 by 1966, a 471% gain. But amid rising inflation and interest rates, the 1,000 mark then became a ceiling for the Dow for 16 years, from ’66 to 1982.
There were bull and bear markets in that period, but a buy-and-hold investor in 1966 would have realized no net price gain in the Dow until 1982.
Investors who made big bets on stocks in the late 1990s may know that feeling.
Despite the rally of the last two years, the Dow, the S&P; 500 and the technology-dominated Nasdaq composite index remain well below their peaks of early 2000. So the net return in five years has been negative.
Even including the last two years of the 1990s market boom, many investors have made little progress: A buy-and-hold investor in the S&P; 500 index has earned an annualized average return of less than 5% a year since Dec. 31, 1997.
Wall Street optimists say blue-chip shares’ weak performance since 1997 might be good news, because it could indicate that the market already has purged itself of most of the excesses of the boom years.
Some also say it’s a mistake to focus too much on the past.
Ted Bridges, a principal at money management firm Bridges Investment Counsel in Omaha, said that as investors look to the future, they compare how the market might perform against the alternatives, including bonds, bank accounts and real estate.
And looking out five years, Bridges said, stocks are “as attractive as anything else out there.”
What’s more, people who invest on a regular basis, such as through 401(k) retirement plans, have made money on at least part of their portfolio this decade because they were buying as the market declined from 2000 through 2002, analysts note.
If the market falls again in the next few years, regular purchases of shares could pay off once prices recover again, in this decade or the next. And in the case of stocks that pay cash dividends, investors would be collecting that income along the way.
Bullish analysts also point out that, although many blue-chip and technology stocks have been hit hard since 2000, investors have earned hefty returns in this decade in small-company stocks, energy shares, financial-services stocks and real estate-related issues, among other market sectors.
“There’s always a bull market somewhere,” said Maxim Group’s Ritholtz.
From a fundamental view, the stock market ultimately is a bet on an expanding economy and rising corporate earnings, both of which are still intact, said Robert Morris, director of equity investments at Lord Abbett & Co., a Jersey City, N.J.-based money manager.
“I don’t see a force that is powerful enough to stop the body in motion,” he said of the economy.
Like Bridges, Morris said stocks had to be viewed “relative to what else you can get for your money.” Even mid-single-digit returns, he said, could beat the alternatives in the second half of this decade.
Duane Hove, a retired aerospace engineer from Manhattan Beach, is expecting more than that from stocks. He believes his portfolio can continue to generate double-digit returns, he said.
Although he lost money in the 2000-02 slump, he said he learned important lessons about paying more attention to what he owned.
The last two years have shown that “there are always opportunities in the market,” said Hove, 60, who now writes history books. “I don’t take the view that it can’t come back.”
