Nervous Bulls, Frustrated Bears - investments in 1998 and 1999

Nation's Business, Feb, 1999 by Randy Myers

Randy Myers, formerly a writer and editor for Dow .Jones & Co., Inc., is a financial writer in Docer, Pa.

For stock-market investors, it is frightening to be bullish but almost impossible to be bearish. Defving pessimistic prognosticators. the stock market shrugged off last year's sickeningly bad third quarter with a fourth- quarter rally that allowed it to post a double-digit gain for the fourth consecutive year.

Down 15 percent during the third quarter, the average domestic stock fund earned 20.2 percent in the fourth, according to Lipper Inc., a Summit. N.J., consulting and research firm. That led to a gain of 14.5 percent for the average domestic stock fund for the full year.

The market's volatile ups and downs have left investors with two nerve-racking options: continue to sock money into stocks and risk another sudden reversal, or pull money out and risk leaving future gains on the table.

"Sooner or later, this 20-percent-plus-a-year business is going to stop, but when, I have no idea." says Henrik Strabo, manager of the American Century-Twentieth Century International Growth Fund and the new American Century-Twentieth Century Global Growth Fund.

For four straight years. the Standard & Poor's 500-stock index has gone up by more than 20 percent a year. an unprecedented achievement.

"It's been a very strange environment," says Samuel Yee. a portfolio manager with PPM America, a Chicago-based money-management firm. "We've felt that the market has been pretty rich for a long period of time but also that there's no reason it couldn't go higher."

Both Strabo and Yee continue to put new money to work in the stock market, partly because--even after the major indexes' lofty gains--some sectors still look favorably priced.

"We are finding values in the middle-sized companies, those with market capitalization of under $10 billion or so. says Yee. "In the capital-goods sector, for example. we see a lot of companies trading at 12 to 13 times their annual earnings, versus 25 times for the stock market as a whole.

"While these are not companies with tremendous earnings growth, they are very cheap stocks, and longer term we think they will work out to our benefit."

The International Influence

Of course, there's a reason that small-company stocks are cheaper than big-company stocks. Investors worry that slumping economies in the Far East, Russia. and Latin America could weaken the U.S. economy, and if that happens, small companies wouldn't have the financial resources to survive as well as big companies. When problems in Russia and other international markets drove the average stock fund down 15 percent in last year's third quarter, the average small-company fund fell 21.5 percent.

But the Federal Reserve Board has taken measures to ward off a slump. Three times in the fourth quarter, it cut interest rates by a quarter of a percentage point to make it easier for consumers and businesses to borrow money and keep the economy simmering. Most professional investors say those rate cuts, more than anything else, triggered the stock market's ferocious fourth-quarter rally.

"Investors [also] saw that the U.S. economy is still in very good shape [with low inflation, low interest rates, and moderate economic growth], and that is enormously important to the rest of the world," says Strabo. "In addition, Brazil's economy did not blow up, as many had feared that it would, and in Southeast Asia we've started to see a turn in the economies and a bit of a recovery in the financial markets."

For all that, it would be foolish to discount the possibility of further turmoil. Long-suffering Japan remains mired in a recession (although Japanese stock funds finally managed a gain in 1998, up 8.2 percent on average), and many developing countries are still financially fragile.

Most investors believe the world economy is now too interlocked for disaster in one region to go unnoticed in others.

"The key is Japan," Strabo says. "If their economy continues to deteriorate and Asia starts to go backward again, I would get a little nervous."

Concerns About Momentum

Even if foreign markets stabilize, some investors worry that the U.S. stock market was too fractured in 1998 to sustain its momentum in 1999. Just as big stocks outperformed small, so did "growth" stocks outperform their "value" counterparts. And some sectors of the market, namely technology stocks, appeared to be in the grip of outright mania.

Goldman, Sachs & Co., a New York City investment bank, calculates that stocks of companies doing Internet-related business averaged gains of 225 percent last year.

Of course, professional investors have been calling the stock market overvalued for several years, yet it hasn't stopped the upward march in prices, especially for stocks of large companies that are perceived to have solid growth prospects.

"We think 1999 will be another year where the largest companies are driving the market," says Stuart Freeman, chief equity strategist for St. Louis-based brokerage firm A.G. Edwards & Sons. "The large, multinational growth companies will have stronger earnings-growth rates than the smaller companies, and the market will pay for that this year."