If you've come to expect stock returns like those over the past two years, you may be in for a rude awakening next year.
Several prominent brokerage-house strategists are predicting something investors haven't seen in a while: a normal year.Averaging out the good and bad years this century, stocks have provided about a 10 percent annual return, including reinvested dividends. And that's just about what some Wall Street strategists see for 1997.
If so, investors might feel as if they were suddenly drinking plain water instead of wine. In 1995, Standard & Poor's 500-stock index rose a heady 37.6 percent, its best performance in 37 years. On top of that, stocks appear to be headed for another rich return this year - about 18 percent, if they finish as strongly as they've started.
"The market's return in 1995 and year-to-date were well above its long-term trend," says Steven Einhorn, co-strategist with Abby Joseph Cohen at Goldman, Sachs & Co. He adds, "1997 promises to be a year that will be on-trend."
Einhorn expects that the economy will grow at a 2.5 percent to 3 percent clip next year, which is in the dull-normal range. He thinks corporate profits will rise about 8 percent. Take that 8 percent figure, throw in a couple of percentage points for dividends, and you have Einhorn's projected 10 percent return on stocks, right in line with historical norms.
Over the 12 months and the five years ended Sept. 30, Goldman Sachs has been the leader in a continuing study of brokerage houses' asset-allocation skill. The study is conducted by The Wall Street Journal with help from Wilshire Associates in Santa Monica, Calif., and Carpenter Analytical Services in Hanover, N.H.
The study estimates how an investor would fare by following the advice doled out by each strategist on how to divide a portfolio among stocks, bonds, cash and other assets.
For a year and a half, Goldman has advocated the same blend: 60 percent stocks, 25 percent bonds, 10 percent cash, and a kicker of 5 percent in commodities. Over the past year, the commodities position has provided a return of 40.4 percent, so even a small dollop of commodities has been a nice sweetener.
Second in the rankings for the 12-month period, and first for the latest quarter, was Lehman Brothers, a unit of Lehman Brothers Holdings Inc. Its strategist, Jeffrey Applegate, looks at 1997 much as Einhorn does, though his numbers are a smidgen higher.
Applegate expects corporate profits to rise 10 percent in 1997, and stocks to keep pace. Tack on two more percentage points for dividends, and you reach 12 percent as his expectation for stocks' total return. Currently, Applegate has the most aggressive blend among the 14 strategists tracked by The Wall Street Journal. He recommends 70 percent stocks, 30 percent bonds and no cash.
Similarly, Christine Callies, recently named the strategist at CS Holding AG's CS First Boston unit (third-ranked for the 12 months) looks for returns of just under 10 percent next year. Stocks are "arguably richly valued," she says, but even high-perched markets "don't spontaneously go down. You need a negative catalyst." And she sees little immediate threat from the two most likely catalysts, inflation and interest rates. At least for a while, she says, "the economy has hit a sweet spot."
Peter Canelo of Dean Witter Reynolds sounds at least equally upbeat, predicting that the Dow Jones industrials will hit 6500 within six months. "You've got no problems from the (Federal Reserve). You've got improving earnings. Why shouldn't stocks go up?," he says.
Pessimists, by contrast, say that even a 10 percent year in 1997 would be a lot to hope for. They point out that the Dow Jones Industrial Average recently cracked the 6000 barrier for the first time, and that stocks are in their sixth consecutive up year, an unusually long streak. What's more, they say, stocks are selling for multiples of book value (corporate assets minus liabilities) higher than the previous record, set in 1929. And they are selling for multiples of dividends higher than the previous record, set in 1987.
But only a minority of brokerage-house strategists see any reason to take chips off the stock-market table. Most of them are advocating middle-of-the-road investment blends, a bit heavy on stocks and a bit light on bonds.
Edward Kerschner, Paine-Webber's chief strategist, explains why he, for one, isn't fazed by the pessimists' worries. That six-year streak? It doesn't matter, says Kerschner, because whether the market rises or falls one year doesn't predict what happens the following year.
The high ratio of stock prices to book value? "In a service economy, book value doesn't have much meaning," he says. As for dividends, he says that companies used to pay out half to two-thirds of their earnings in dividends, "which was kind of stupid. People were myopic and they thought a bird in the hand was worth many in the bush." Nowadays, he says, corporations are more likely to use extra money to buy back stock or expand operations, rather than raise dividends.
Among all 14 strategists, the average recommended blend stands at 57 percent stocks, 31 percent bonds, 11 percent cash, and 1 percent other assets (such as gold or real estate). That isn't far from a traditional textbook blend of 55 percent stocks, 35 percent bonds and 10 percent cash.
In what could be a blow to some Wall-Street-sized egos, only half of the strategists over the past five years have beaten The Wall Street Journal's mythical "asset-allocation robot." The robot always uses a traditional textbook blend. The robotic approach has led to a 74 percent return over those five years. Returns for the live (and highly paid) strategists have ranged from 65.6 percent to 82.3 percent.