Stock market faces an uncertain 1998

Nation's Business, Feb, 1998 by Randy Myers

It really was different this time. Defying skeptics and historical precedent, the U.S. stock market soared again in 1997, allowing the Dow Jones industrial average to post a gain of more than 20 percent for the third consecutive year. It was a feat never before accomplished.

Investors whose portfolios mimicked the Standard & Poor's 500-stock index of large-company stocks have now roughly doubled their money in that three-year period, a phenomenon that in the past has taken an average of seven years to accomplish.

Researchers at Lipper Analytical Services in Summit, N.J., say the average stock mutual fund -- the most popular investment vehicle for many individual investors -- earned 24.4 percent last year and has now posted average annualized returns of 25 percent for the past three years.

Despite the logical argument that the market can't go up forever, Wall Street analysts and money managers give stocks a better-than-even chance of advancing again in 1998, albeit not as dramatically and not without potentially volatile ups and downs.

They are cautious for good reason. Unlike last year at this time, when there were no significant threats on the market's immediate horizon, this year a potential sinkhole looms in the form of the widely reported economic crisis in Southeast Asia.

The fallout from that crisis, which sent Asian currencies and stock markets alike into a tailspin in recent months, hit these shores on Oct. 27. On that day, investors, who had become increasingly nervous about how the crisis would affect the U.S. economy, sent the Dow Jones industrial average tumbling 554 points. That was the Dow's biggest one-day point decline in history, although it ranked only 12th in terms of percentage decline -- 7.1 percent.

Too Soon To Bury The Bull

Although that sell-off on Oct. 27 presaged a tough fourth quarter -- the average U.S. stock fund tracked by Lipper lost 1.5 percent from October through December -- most analysts are loath to forecast the bull market's death just yet. If it does expire, though, they suggest that the most likely villain will be the Asian crisis and its detrimental impact on U.S. corporate profits.

"When Thailand's markets blew up and this problem began to spread, it made headlines but didn't impact major markets around the world," observes Henrik Strabo, manager of the American Century-Twentieth Century International Growth fund. "When the turmoil reached South Korea, a much larger economy, people started to get really concerned. I think we can live with a troubled South Korea. But the real question mark now is Japan, the world's second-largest economy. How bad a shape are they in?"

Early pronouncements from Wall Street economists focused on the notion that exports to the Far East represent a relatively small fraction of the U.S. economy, and thus it wouldn't be decimated by a slump in Asia. Strabo isn't forecasting catastrophe either, but neither does he believe we'll escape unscathed. "You can't take such a big part of the world that had been growing very fast and slam on the brakes without impacting other businesses around the world," he says. "That's just unrealistic."

U.S. investors who sought to optimize their returns by putting some of their money into international mutual funds last year have already suffered. According to Lipper, the average diversified international fund lost 7.7 percent of its value in the fourth quarter of 1997, leaving it up just 5.4 percent for the year.

Funds focused exclusively on Southeast Asia did much worse. The average Pacific fund, excluding Japanese funds, lost 28.6 percent in the fourth quarter and 35.5 percent for the full year. Japanese funds lost 15.4 percent in the fourth quarter and 14.1 percent for the year.

Market Gains Ahead?

If the Asian crisis doesn't knock the legs out from under the U.S. economy, the stage would appear to be set for moderate gains in the U.S. stock market in 1998, according to Jay Sekelsky, lead equity manager for the Mosaic family of mutual funds in Madison, Wis.

One strong reason: declining long-term interest rates, which in 1997 helped the average taxable domestic bond fund earn a total return of 8.65 percent. (Bond prices rise when interest rates fall.)

The interest rate story is almost as compelling as the Asian story. The Treasury's bellwether 30-year long bond started 1997 yielding 6.64 percent, climbed to 7.17 percent by early April, then began a decline that it to 5.92 percent at the end of the year.

By the first week of January, long-term rates had fallen as low as 5.73 percent, the lowest they had been since the 1960s (and for a brief period in the 1970s). Low interest rates encourage consumer spending and cut corporate borrowing costs, which helps corporate America and stock prices.

"Rates may not drop as rapidly in 1998 as they did over the last six months of 1997, but I believe we can keep the 30-year Treasury below 6 percent for the better part of the year," says Sekelsky.

While he suggests that the stock market was fairly valued at the end of 1997 relative to corporate earnings, he adds that continued low inflation and interest rates and modest corporate-earnings growth this year could produce returns of 5 to 12 percent in the stock market, in line with historical standards. (From 1926 through 1996, large U.S. stocks have produced a compound annual return of 10.7 percent, according to Ibbotson Associates, a Chicago-based research firm.)