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Wall Street's 2007 stock forecast has a familiar ring

December 31, 2006|Tom Petruno | Times Staff Writer

Many professional investors' stock market forecasts for 2007 are following a time-honored strategy: Restrain your expectations and you're less likely to be disappointed.

The typical outlook of money managers and market strategists is for a price gain of less than 10% in U.S. blue-chip stocks, more-modest returns on smaller stocks, and a general hankering for higher-quality investments over riskier ones.

And yes, you've heard this all before. A year ago, in fact.

Those restrained expectations for 2006 were comfortably exceeded, for the most part. Instead of a single-digit return, the blue-chip Standard & Poor's 500 index gained 15.8% this year, including dividends. It was the biggest calendar-year advance since 2003.

Smaller stocks? The Russell 2,000 index of that universe produced a total return of 18.4% for the year, beating blue chips, although the S&P 500 did manage to edge out some other indexes of smaller shares.

Higher-quality investments over riskier ones? For sure, it was a good year to stay away from Saudi Arabian stocks, which plummeted 52%. (Foreigners aren't allowed into that market, anyway.) But that was the glaring exception in another stellar year for emerging markets. The average emerging-market stock mutual fund soared more than 32%, according to research firm Morningstar Inc.

The consensus forecasts for 2006 were wrong, but few investors are likely to complain. The rising tide lifted all boats, although some were lifted higher than others.

Most important, you earned far more in stocks than you did in bonds or cash accounts. And that's the acid test for many people.

Given the results of 2006, those on Wall Street who make their living predicting market moves have no reason to venture too far out on the optimism scale for the new year. Why not just play it safe, and hope to be pleasantly surprised again?

Hence, the average price gain predicted for the S&P 500 in 2007 is 9%, according to a Bloomberg News survey of investment strategists at 14 major brokerages.

That sounds good to Sam Stovall, strategist at Standard & Poor's in New York. He's also in the upper-single-digit return camp for '07.

"Soft and sweet," he calls the forecast.

But he admits that taking a stance away from the majority view will be tempting for some investors who don't like to be in a crowd, especially a relatively boring crowd.

That could mean betting that stocks fall instead of rise -- or that it's time to go for broke, betting on a wild rally that blows out all the stops.

Jason Trennert, who maps strategy for Wall Street research firm Strategas Research Partners, likes the wild-rally scenario.

Fear of losing money in stocks, he says, has kept many U.S. investors too cautious since 2002, when the current market upturn began. But the natural progression of a bull market, he says, is "fear giving way to greed."

It's easy to argue that that already has happened in many foreign markets. Could it be the U.S.' turn?

"I think the higher-octane stuff, the riskier assets are going to be the best performers" in 2007, Trennert says, mentioning biotechnology and software as two potential standout sectors. (Both lagged in 2006.)

Closer to the other end of the sentiment spectrum is James Stack, the veteran editor of the InvesTech investment newsletter in Whitefish, Mont., and a conscientious student of market history.

"You look at this market and it's hard to find fault with it," Stack concedes. But he found some, anyway.

Most investors have grown dangerously complacent, he says, precisely because there have been so few significant interruptions in the steady upward trend in share prices since 2002. Complacency is an invitation to disappointment.

He also believes that the Federal Reserve is right to keep warning that inflation pressures are simmering in the economy, as wage growth picks up and as a weaker dollar threatens to raise import prices.

"The biggest surprise that could upset the apple cart," Stack says, "is if the Fed has to return to tightening credit" -- which is exactly what Fed Chairman Ben S. Bernanke has been warning about for months, even as the central bank has kept its benchmark short-term interest rate at 5.25% since June.

Yet for now, Stack agrees that there are no significant signs that the bull market is ending.

That's also one reason why so many professional investors find it comfortable to stay in the middle ground, expecting that, at worst, the U.S. market muddles through with single-digit returns in 2007. The common refrain to stick with higher-quality stocks is the crowd's nod to the risk of jarring potholes along the way: Better to ride in something that would be better able to withstand some shocks.

Fundamentally, the No. 1 reason to stay bullish is that the optimistic economic assumption still appears to be intact -- which is that the U.S. is in the midst of a "soft landing" of weaker growth that may slow corporate earnings gains for a time but won't halt them.

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