Ladies And Gentlemen … Dow 25,000 - stock market forecast - includes related article on technology stocks

Kiplinger's Personal Finance Magazine, Jan, 2000 by Manuel Schiffres

COVER | After a great decade for STOCKS, are you ready for another good one? Keep your spotlight on technology.

Sure, there are reasons to worry. Key measures of the stock market's value are at or near record levels. The gap between how much we buy abroad and how much we sell overseas is turning into a chasm. The dollar is declining in value against other currencies and oil prices are way up, creating inflationary fears. The Federal Reserve Board, meanwhile, has an itchy trigger finger--it seems to have an irresistible desire to raise interest rates. The wall of worries, in fact, seems endless.

But if the last decade has taught you anything, it is that there are always lots of worries that at the moment seem to be impediments to higher share prices. And yet the earnings roll in, the economy purrs along and stock prices ultimately keep rising. We see this marriage of worry and investment profits continuing through the coming decade.

But first, what to expect from the year ahead: Assume, as we do, that the supposedly vicious year-2000 computer bug turns out to be toothless, or at worst a mild irritant. Stocks will rally on the realization that the world isn't ending (see "The Y2K Itch," Nov.). After that, though, it's back to the worry wall. Stocks will struggle with each announcement that suggests inflation may be accelerating. But before the year ends, the rising interest-rate trend that began in 1999 will help slow the economy, calm investors and return stocks to their upward trajectory.

Expect the major indexes of U.S. stocks to deliver returns of 10% to 15% in 2000. While earnings growth won't be as impressive as 1999's expected 14% jump, analysts see profits for Standard & Poor's 500-stock index climbing a respectable 9% in 2000. Lower interest rates (the yield on 30-year Treasury bonds will fall below 6% during the course of the year) should allow price-earnings ratios of stocks to expand slightly and bump up stock prices.

These are short-term developments whose impact pales in comparison with the benign trends that will drive the markets over the next decade. Many of these trends began during the 1990s and should continue indefinitely. They include:

* The spread of capitalism around the globe, creating wealth that spawns hundreds of millions of new consumers and intensifies competition among companies.

* The increasing importance of technology, which helps businesses become more productive and thereby limits inflation. The emergence of the Internet is a key contributor to this development. Businesses use it to contain costs, and consumers to comparison shop.

* The continued influence of the 75 million Americans born between 1946 and 1964, the bulk of whom are in their prime saving years. Much of those savings will be funneled into stocks, supporting prices through thick and thin. Consider this a happy accident of history.

What to key on: Inflation

THE FUNDAMENTAL underpinning to a healthy stock market is solid profit growth and low inflation and interest rates. In fact, inflation and interest rates may determine stock prices even more so than profits. J.P. Morgan Securities strategist Douglas Cliggott recently reported that in various periods since 1961 stocks performed poorly when inflation misbehaved, even when profits were soaring. But when inflation calmed down, share prices generally advanced even when earnings didn't grow robustly.

The logical conclusion: If inflation and rates remain quiescent, investors will pay at least as much for every dollar of profit a company earns as they do today. That would allow the market to maintain its lofty P/E ratio--recently 25 based on consensus profit estimates for 2000--and permit share prices to rise in line with profit growth.

Interest rates, in turn, react to inflation expectations. So what to expect from inflation? Despite recent evidence of a pickup in inflation prompted by the brawny economy, it's not about to swing out of control. As Lehman Brothers economist Stephen Slifer explains it, inflation will remain low because businesses are having trouble raising prices. That, he says, is due to increasingly intense foreign competition, tougher domestic competition sparked by companies catering to price-conscious consumers and the impact of the Internet, which Slifer calls "the most deflationary event of our lifetime."

Some observers, such as James Paulsen, chief investment officer at Wells Capital Management, predict that inflation will virtually disappear over the next decade. He sees the inflation rate resting at zero. In that event, yields on long-term Treasury bonds could plunge to 3 %, from today's 6.1% rate. Stocks would soar as P/E ratios climb higher still. Okay, so maybe Paulsen is too rosy-eyed for your taste. Gary Thayer, chief economist for the A.G. Edwards brokerage, sees long-term inflation at 2% a year and the long-term Treasury bond yielding between 4.5 % and 6.5 % over the decade. Again, stocks would thrive, though perhaps not quite as much.

A low-inflation world, however, puts businesses over a barrel. If they can't raise prices, how will they boost profits? By becoming more efficient or by expanding their markets. They'll do both in the next decade. "Basically, we've gone from roughly 300 million consumers that companies could sell products to before the collapse of communism, and it's heading to four or rive billion," says Gary Tapp, an analyst at Robinson-Humphrey brokerage. "This is very positive for U.S. corporations, which are the most competitive and the best in the world at marketing and research and development."