After enduring a recession, the bursting of the dot-com/telecom bubble, and a terrorist attack on New York and Washington, the major U.S. stock markets look to have put the worst behind them, and many market-watchers are hopeful that next year they can build on their recent rally. Does that sound familiar? It should, because that description of the current situation is almost identical to the investment picture a year ago.
As 2001 came to a close, most of the major brokerage firm strategists and economists were looking for a better-than-average — in some cases, much better than average — performance from the markets in 2002. The Dow Jones average, the Nasdaq market index and the Standard & Poor's 500 average had all rallied strongly from their lows following the September 11 attacks, and that gave many investors hope for what was to come.
The Dow rose above 10,000 in December (up about 23 per cent from its post-Sept. 11 low) and the Nasdaq climbed past 2,000 (up 44 per cent), as stronger economic data and some good corporate news — from bellwethers such as Cisco Systems — boosted hopes for future profits. In case you're keeping track, the Dow is down about 1,500 points or 15 per cent from that level and the Nasdaq is down 600 points or 30 per cent.
As the markets moved higher late last year, many saw this as evidence that investors were looking "across the valley" to better earnings in 2002, and that this hope would be fulfilled. In November, Thomson Financial/First Call said most analysts were expecting S&P profits to climb by 10 per cent in the second quarter and 30 per cent in the third quarter. Tech stocks were expected to boost their profits by 44 per cent in 2002.
Equity strategist Ed Kerschner of UBS PaineWebber expected the S&P 500 to climb by 35 per cent in 2002 to about 1,600 — almost twice what it is now. Abby Joseph Cohen of Goldman Sachs saw the S&P at 1,300 and the Dow at 12,500, while Jeff Applegate of Lehman Brothers saw the S&P at 1,350. "What this market is telling you is that economic recovery next year is an absolute certainty," said Henry Cavanna of JP Morgan Fleming.
Even though the market looked overvalued — with the S&P 500 trading for more than 25 times earnings — the argument was that it looked cheap based on future profits. "I agree that the valuation of the stock market is high right now. But that is fairly typical during a profit trough," Christine Callies of Merrill Lynch told USA Today. "Price-earnings multiples will come down gradually over time as earnings growth improves."
One guarantee that things would get better, some strategists said, was the fact that the major U.S. stock indexes had not had three down years in a row since 1939-1941. Even two down years in a row was fairly rare for the Dow and the S&P index, the experts said (the last time was 1973-1974), so it seemed like a good bet 2002 would be rosy.
Virtually the only major equity strategist looking for a down year in 2002 was Doug Cliggott, then at JP Morgan. He said the S&P 500 would close 2002 at about 950, down 18 per cent. "What we think this rally looks and feels like is the strong positive market move in spring 2001," Mr. Cliggott wrote in December. "And just as that rally faded, and prices eventually broke down to new lows, we think this one will too." Mr. Cliggott has since left to work for a Swedish hedge fund, Brummer & Partners.
The bearish case was that the massive runup in stock prices from 1998 to 2000 was a market bubble of unprecedented size — and that such a bubble couldn't simply evaporate in a year or two without long-term damage. In particular, they said, corporate spending would likely stay depressed because of the dramatic buildup in inventories of a host of products and equipment, from computers and cell phones to fibre-optic capacity.
The bulls dismissed this theory, in large part because of the magic of the Federal Reserve and chairman Alan Greenspan's repeated interest rate cuts. Every other time in history, such cuts were inevitably followed by a market rally. As 2001 turned into 2002, however, those rates led to plenty of activity in housing, but little in the area of corporate spending and industrial activity, a key growth engine.
As the year ends in 2002, investors are faced with many of the same conundrums as they were in December of 2001. Will the strength of the consumer sector fade before capital spending picks up? Have companies put the bad news behind them, or is there more to come? Will profit targets have to come down next year, as they had to be revised downward in 2002? And will investors be as wrong next year as they were this year?
In the end, perhaps UBS Warburg technology strategist Pip Coburn said it best almost a year ago today. "We used to be convinced that we knew what was going to happen," he told the Wall Street Journal in December of 2001. "Now we're aware that know very little."
E-mail Mathew Ingram at mingram@globeandmail.caLook for exclusive Mathew Ingram commentary at GlobeInvestorGold
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