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A Briefing for Investors

OK, Take 2 of These Analysts and Call Me in the Morning

June 03, 1998|TOM PETRUNO

Stop worrying already!

That's the message for U.S. equity investors from two of Wall Street's most respected market strategists--Edward Kerschner of PaineWebber Group and Abby Joseph Cohen of Goldman, Sachs & Co.

"Last week's market gyrations do not portend any real problems for the stock market," Kerschner insisted in a memo sent to clients on Sunday.

"Home on the Range: Higher Stock Prices Ahead," Cohen titled a report to clients on Monday.

Their words may not be much comfort to investors who own some of the individual stocks that have, in fact, been in steep decline in recent weeks. But Kerschner and Cohen are talking about the big picture, and primarily for the blue-chip Standard & Poor's 500 index companies.

Their views carry weight because both have been steadfastly--and correctly--bullish in recent years, even as the market has risen to levels that have given professional portfolio managers a collective lump in the throat.

*

Why not be worried about U.S. stock prices today, given weak corporate earnings growth, rising turmoil in emerging markets and the Federal Reserve Board's potential trigger finger with interest rates, among other concerns?

Here's how the two strategists make their case for staying in U.S. equities overall, with the S&P 500 now off 3.3% from its record high set April 22:

* Kerschner: Yes, corporate earnings growth has slowed. Nonetheless, the important distinction to be made is that "earnings are unlikely to fall," the PaineWebber strategist says, referring to results for major U.S. companies.

"We still look for earnings per share growth [for the S&P 500] of 5% to 10% in the second half of 1998 and into 1999," Kerschner says.

Second, he says, "The market's price-to-earnings ratio is unlikely to fall." Although blue-chip stocks are, by most reasonable estimates, priced at more than 20 times estimated 1998 earnings, on average--a historically high P/E--Kerschner maintains that "benchmarked against either inflation or bond yields, P/Es seem rational. The stock market remains essentially fairly valued. . . ."

Your definition of a "normal" price for stocks may differ from Kerschner's, of course, but by his reckoning of value--measuring the market's height relative to earnings, inflation and interest rates--"stocks have not sold below 90% of normal P/E valuation since January 1991."

In other words, Kerschner is saying that this long bull run in the 1990s has been fully justified by the underlying fundamentals, and that investors have responded to those fundamentals by refusing to let stocks fall more than 10% from "fair" value.

What if he's wrong about the near-term outlook, and the Dow (now at 8,891.24) should drop to, say, 8,000--a 13% decline from its recent record high?

"While unlikely, today an 8,500 Dow would be the best buying opportunity since the summer of 1996," Kerschner insists. "And, should it somehow occur, an 8,000 Dow would be cheapest market since year-end 1990--in the midst of the Middle East conflict."

* Cohen: Abby Cohen has practically become the embodiment of serene bullishness on Wall Street. She's not about to shed that image now.

"The fundamentals remain intact, and we expect [stock] prices to rise in coming months as investors focus on, one, economic and profit expansion, which we project to continue through 1999; two, government budget surplus; three, well-managed corporations; and four, solid financial institutions," Cohen says.

Like Kerschner, Cohen maintains that stocks are "priced roughly at fair value." She expects the market to churn for a period of weeks or months, forming another flat "stair" in what she has dubbed the "staircase pattern" of the 1990s bull market--sharp advances followed by periods of mostly sideways movement rather than steep declines.

"Because the overall market is priced roughly at fair value, there is sensitivity to potential disappointments," Cohen allows. But while East Asia, Russia and other emerging economies are struggling with massive problems, "the basics in the United States remain very sound," she says.

*

She views the modest, single-digit growth rate of blue-chip corporate earnings in the first quarter as something of a positive, in that it occurred despite the backdrop of "weak global demand, declining commodity prices and a strengthening dollar."

She still expects profits overall to rise 8% this year, which assumes "some modest improvement in economic activity among our trade partners later in the year."

The bottom line for stocks: "We reiterate our 'easily achieved' year-end projections on stock price indices: S&P 500 at 1,150 [a 5.2% rise from current levels] and Dow at 9,300 [a 4.6% rise]," Cohen says.

Everybody feeling better yet?

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