•We are patient bulls on the medium-to-long-term prospects
for US equities.
• For some time, we have applied comparatively optimistic
multiples ranging from 25 to 28 to estimates of the operating
earnings of the S&P 500. Similarly, we have relied on the
remarkable stability of the growth trends in US GDP and
domestic consumption spending for our forecasts of the
resilient growth in the profits of blue-chip companies. We see
very little reason to change those assumptions for the second
half of 2000.
• One of our central ideas is that lower volatility in GDP and
inflation trends translates into higher valuations in the financial
markets. Lower volatility is one of the indirect benefits of
heavy investments in technology and information systems; that
investment spending, in tum, improves the predictability of corporate
revenues and earnings. That is a key point, because “visibility”
has long been associated with premium valuations at the
sector level. If the scarcity value associated with good visibility
translates into premium multiples for a sector, it should also
translate into optimistic multiples for equities as an asset
class. Another important element in our view of the market’s
valuation is this: the deregulation of the commercial banking
industry and the dissolution of Glass-Steagall in the 1990s
changed the decades-long boom-and-bust nature of the liquidity
cycle. Now, the supply of credit no longer evaporates as interest
rates rise.
• Against that background, we think that S&P 500 operating
earnings per share for 2000 will increase by 15% to $58.44; our
projection for 200 I is an increase of 9% to $63.69. Applying
a multiple of 27 to the index produce a year-end objective of
1575 for 2000 and a preliminary one of 1720 for 200 I. The
index was recently 1460, in line with that view, we think that
investors should buy the dips during the third and fourth quarters
of this year.
•Investors’ recent rotation into the financial, health care and consumer-
staples sectors is an expression of their jitters about the
stability of quarterly profits during a soft landing. If the market
is correct in assuming that a soft landing has already
occurred (we are highly skeptical that it has done so), historical
data suggest that the effect on S& P 500 profits growth might
not be evident until at least the middle 200 I.
• The presidential election notwithstanding, the skill and political
acumen of the Federal Reserve will be more important to
the financial markets during the next six months than who wins
or loses in November. A look at changes in interest rates plotted
against earnings shows that rising interest act as a drag on
the performance of the stock market when earnings growth is
already positive. That means that, at this stage of the cycle, what
the Fed does or does not do is still central to equity-market returns. We think that there is little or no need for the FOMC
to raise the Federal funds rate at the August 22 meeting. However,
we think that the economic data for the second half of the
year will be too “noisy” to allow investors to reach a high level
of hulljsh conviction about the future direction of monetary policy
or the stock market’s appropriate valuation level. Consequently,
we think that it will be a bumpy ride up to our year-end
S&P 500 objective of 1575.
• What about sectors? The consumer, financial and technology
sectors hold the key to 200 I, in our judgement. We see the
potential for increasingly synchronous behavior among those
areas. The relationship can best be envisioned by imagining the
financial services sector as the facilitator of commerce
between the other two; the key linkage in the system is the availability
of credit and its price.
• As we see it, the spending patterns of the baby-boomer generation
suggest that investors’ expectations for selected consumer
stocks may be too pessimistic. Indeed, the intersection
of the multi-year bull market in equities and the maturation of
the baby-boom generation may be setting the stage for more stable
spending-growth patterns than investors are accustomed to.
Economic data show that baby-boomers were aggressive
shoppers before they were prosperous. They are quite prosperous
now: the population segment with the largest portion of
unrealized capital gains is families earning at least $100,000
a year and headed by someone 45 or older. That bodes well for
future spending, particularly because debt-service levels
appear to be acceptable in relation to income.
• In the tech sector of the stock market, the recent correction is
in a mature phase, in our view, and structural demand remains
healthy in light of the robust level of unfilled orders. Taking a
broader view, demand is likely to remain strong as some companies
continue to spend heavily for productivity-improving
technology to defend their profit margins, and others do so to
boost capacity. We doubt that either motive will dissipate
unless the overall economy falters badly.
• Where do financials fit in? Financial companies have spent
heavily for technology capital equipment; they have also
helped to provide the financing for tech companies themselves
and for consumer spending. That inter-relationship
relies heavily on healthy and liquid capital markets, and it means
that the Fed can abort the tech boom if interest-rate policy posts
an upside surprise.
• In our view, the best resolution to the market’s uncertainties
would be the appearance of a second phase of the tech revolution,
one that uses technology to increase the capital efficiency
of the more traditional areas of the economy. That would let
investors make the case for another new bull-market cycle.
