Aging Bull
Can the market kick up its heels one more time?
Wall Street is already trimming estimates of corporate profit growth this year, Schweitzer notes. Six months ago, he says, analysts were forecasting S&P 500 profit growth of more than 10.5 percent. Since then, forecasts have fallen by more than a percentage point.
So, why are investors-who've historically preferred climbing walls of worry to ladders of hope-suddenly acting like Alfred E. ("What, me worry?") Neuman?
Part of it may have to do with history. This is the third year of President Bush's second term. Since World War II, notes Sam Stovall, chief investment strategist for S&P, the 500 index has never lost money in the third year of a presidential term. In fact, third-year gains have averaged 18 percent.
The bullishness may also stem from investors' recent experiences. There's an old saying on Wall Street: Investors tend to think that things will forever be the way they are.
Both the economy and corporate profits have recently proved far more resilient than expected. Last year, the economy weathered recession worries and a housing slowdown, as corporate America found a way to accelerate the pace of earnings growth. "Profits just continue to amaze analysts and strategists," says Jack Ablin, chief investment officer for Harris Private Bank.
Today, investors aren't simply banking on a so-called soft landing for the domestic economy. "The market is bracing for the plane to circle the runway and take off again," says James Swanson, chief investment strategist for MFS Investment Management.
This optimism is reflected in continued risk-taking among investors, Swanson says. Toward the end of last year, the best-performing segments of the market were the riskiest: emerging-markets stocks, small-company stocks, and commodities. Shares of blue-chip companies, which were expected to lead the market, wound up laggards yet again (Page 73). The average large-cap growth fund rose just 7.3 percent in 2006, while small-cap growth funds surged 11.1 percent.
Many on Wall Street think a change is in the air. A Russell survey found that money managers are most bullish on large-cap growth stocks and favor blue-chip foreign stocks over emerging-markets shares.
Of course, investors made a similar bet at the start of 2006 and turned out to be wrong. So how can you tell whether the markets will be in a speculative or safety-seeking mood this year?
Keep an eye on relative growth overseas. The developed economies of western Europe, Japan, and the United States are predicted to trail considerably behind growth in the emerging markets. Stovall expects 2 percent economic growth in the "eurozone" nations and 1.9 percent in Japan, compared with 4.8 percent in Latin America, 5.9 percent in Europe's emerging economies, and 6.8 percent in Asia's developing countries. If the emerging markets continue to outpace the developed world, it should be another solid year for emerging-markets stocks and other speculative assets.
Heed the bond market. Right now, all eyes are on the Federal Reserve as investors try to guess when the central bank will start to cut rates to jump-start U.S. economic growth. But the Fed controls only short-term interest rates. And long-term rates, set by the bond market, have been the real story as of late.
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