Analysts forecast smaller gains for 1997

Nation's Business, Feb, 1997 by Randy Myers

Talk about an encore. The stock market stormed to new highs for a second consecutive year in 1996, surprising its skeptics with its strength and stamina. Despite concerns about pushing their luck, most Wall Street strategists see further, albeit smaller, gains in 1997.

Their caution isn't surprising. After watching the average U.S. stock fund advance a breathtaking 31 percent in 1995, most investment analysts had predicted only moderate gains for 1996. Instead, the Dow Jones industrial average soared an additional 1,331 points, and the average stock fund posted a total return of 19.5 percent, extending the bull market for a sixth consecutive year.

The compounded two-year return of 56.2 percent earned by stock funds in 1995 and 1996 represented the markets best back-to-back-performance since 1978 and 1980, when the average fund rose 75.1 percent, according to LipperAnalytical Services Inc., a mutual-fund research company in Summit, N.J.

"It was definitely a great market," says Kevin Parke, director of equity research at Massachusetts Financial Services, Operator of the MFS family of funds. "I'm always surprised when the market gives me more than 10 percent, and anybody who's not should check their reality schedule."

A Mixed Outlook

For all that, Parke still doesn't think the stock market is unreasonably priced. The same factors that drove stocks higher in 1996--low and stable interest rates, low information, and healthy corporate profits--should allow the market to post further gains in 1997, he suggests, perhaps earning investors as much as 12 percent if kits investment thesis proves correct.

Wall Street's outlook for the bond market isn't so sanguine. The average taxable domestic bond fund posted a total return of just 4.69 percent last year, held in check by a stronger-than-expected economy that grew 2.9 percent through the first nine months of the year. Bond investors worried that if the economy got much stronger, the Federal Reserve Board would raise short-term interest rates to head off inflationary pressures. When interest rates rise, bond prices fall.

At the end of 1996, that scenario looked less than probable. Fifty-one business and academic economists surveyed monthly by Blue Chip Economic Indicators forecast gross domestic product growth of just 2.2 percent for 1997, and a slight increase in the prime interest rate to 8.33 percent from 8.29 percent in 1996). The consensus forecast also calls for inflation, as measured by the Consumer Price Index, to remaining check, hitting 2.9 percent for the second year in a row.

"Inflation will be the key factor," says David Albrycht, manager of the Phoenix Multi-Sector Fixed-Income Fund. "If it remains under control--which we expect--rates will ultimately go answer.

Steady Performers

Despite Wall Street's benign outlook for the financial markets, it wasn't easy to find bargains heading into 1997. In the stock market, many money managers started the year favoring many of the same sectors that performed well in the fourth quarter of 1996, including real estate, financial services, and technology companies.

Real-estate funds soared 15.9 percent in the fourth quarter and 30.8 percent for all of 1996, second only to natural-resources funds, which were inflated by a yearlong rally in energy prices that few analysts expect to see duplicated in 1997.

Thomas Van Leuven, an investment strategist for J.P. Morgan Securities Inc., notes that real-estate funds tend to do well when the economy is doing well because that's when occupancy rates and rental rates are strong Real-estate funds pay higher dividends than the average common stock, and those dividends could prop up returns for real-estate investors this year if the rest of the market doesn't live up to expectations.

In the financial sector, bank stocks continue to benefit from mergers-and-acquisitions activity, stable interest rates, healthy loan portfolios, efficiencies gained from restructuring efforts, and growing fee-based business activities. Parke says those factors should help banks perform well again in 1997. Insurance stocks could also climb as insurance companies begin to reap restructuring efficiencies similar to those already enjoyed by banks.

"We also remain committed to the technology sector, which was one of the strongest sectors of the market last year with gains in excess of 45 percent," Parke says. "That was driven by the huge profit growth Tn this industry, particularly among computer software companies."

Looking Abroad

Although most international stock markets lagged the United States' over the past two years, Paul Boltz, chief economist with T. Rowe Price Associates, in Baltimore, reminds investors not to overlook international markets in 1997. His firm is particularly intrigued by the prospects in Latin America and Europe. Funds that specialized in those two regions outperformed U.S. stock funds on average last year, with gains of 27.4 percent and 23.9 percent, respectively.

For fixed-income investors, the best opportunities in 1997 may lie outside traditional sectors of the bond market. While U.S. Treasuries, municipal bonds, and high-quality corporate bonds all turned in mediocre results last year, high-yield corporate securities, also known as junk bonds, and emerging-markets debt posted outstanding results.