Barron's Cover
| SATURDAY, OCTOBER 30, 2010Bears,Beware!
America's money managers say stocks are cheap and the economy will keep growing. Why they're bullish on tech, bearish on Congress.
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THINGS ARE MORE TOPSY-TURVY than ever on Wall Street this fall. The mercury is rising and the speculative sap is flowing, even though September and October historically have been among the worst months for stocks. Instead of the usual meltdowns, a powerful rally since Aug. 31 has lifted the Dow Jones Industrial Average and Standard & Poor's 500 by about 12% apiece, while the tech-stock-fueled Nasdaq Composite has surged 18%.
Spurring stocks on are strong corporate-profit reports, still-cheap equity valuations and, above all, the likelihood that the Federal Reserve will make good on its promise to flood the financial system with fresh funds to stave off another recession. No wonder America's money managers are more bullish today than they were six months ago—and more confident, too, that the U.S. economy will get back on its feet someday soon.
Scott Pollack for Barron's
Sixty percent of the professional investors participating in our fall Big Money poll say they are upbeat about the stock market's prospects through next June, compared with 46% who called themselves bulls six months ago. Most of the newly minted optimists hail from the fence-sitters' camp, as the percentage of managers neutral about stocks has fallen to 25% from 38% in the spring. The bears' ranks are little changed at 15%, down from 16% in our prior survey.
Like many Big Money managers, Charles Lemonides, chief investment officer at New York-based ValueWorks, which manages $175 million, cites expectations of a stronger economy to explain his sanguine market view, "Monetary policy is working," says Lemonides, who predicts the Dow will rise to 11,500 by year end and 12,600 by mid-2011. "People can complain that it's not working fast enough, but I see no justification for a double dip"—that is, a second recession.
Gross domestic product grew at an annualized rate of 2% in the third quarter, up from 1.6% in the year-ago quarter and 1.7% in the second quarter, the government reported Friday. "We're in a classic, if somewhat slow, economic recovery," says Robert Leggett, chief investment officer at FirstMerit Bank in Akron, Ohio, which runs $2.5 billion. Leggett, too, sees the market rising sharply through the middle of next year.
![[BMP_W36]](http://barrons.wsj.net/public/resources/images/BA-AU157_BMP_W3_NS_20101029165705.gif)
ON AVERAGE, the Big Money bulls expect the industrials to advance another 1% this year, and about 6%, to 11,768, through June. Their mean S&P 500 forecast calls for a 1.3% gain through year end, and a 7% pick-up through mid-'11, which would leave the index at 1263. While they don't see the Nasdaq doing much for the rest of 2010, their June 2011 price target is 2553, up 2% from here.
If these mean predictions seem modest, that's partly because the market has rallied nicely since the survey was e-mailed to participants in late September. At that time, the Dow was around 10,750, the S&P near 1140 and the Nasdaq at 2350.
With the S&P 500 trading for under 15 times 2010 expected earnings of about $79.60, and 13 times next year's profit consensus of $91.11, valuations look reasonable to many poll respondents. So long as interest rates stay low and earnings keep rising, price/earnings multiples, particularly of companies with big exposure to emerging markets, are likely to expand, says Alan Cole, president of Chicago-based Cedar Hill Associates, which oversees almost $1 billion.
Only 10% of Big Money managers think stocks are overvalued today, while 53% consider them undervalued. More than 80% of managers expect to be net buyers of stocks in the next six to 12 months, up from 77% who had such plans last spring.
"Stocks are cheap based on historical price-to-earnings ratios," says Doug McEldowney, senior vice president of Northern Trust, and co-manager of the $184 million Northern Large Cap Value Fund (ticker: NOLVX). He cites the so-called rule of 20, which posits that the market is fairly valued when its P/E plus the inflation rate equals 20. Given today's P/Es and an inflation rate of only 1.1%, U.S. stocks have room to run.
McEldowney, based in West Palm Beach, Fla., sees multiple-expansion lifting the Dow to 11,800 by year end, and 12,750 by mid-2011. He favors large-cap stocks and companies with big dividends and lots of earnings from overseas.
With bonds overbought and stocks underowned, he anticipates a coming "inflection point" in investor behavior. "Investors concentrate too much today on 'return of my money' instead of 'return on my money,'" McEldowney says. "The risk-reward relationship is leaning toward equities. I can invest in stocks and earn a higher dividend yield than the 10-year Treasury yield, with the added potential for principal growth."
FOR ALL THEIR BULLISHNESS, only 62% of Big Money managers think stocks will be the best-performing asset class in the next six to 12 months. Nearly 15% expect precious metals to do best, while 13% say other commodities will lead.
Almost all commodities have rallied in anticipation of another round of quantitative easing, or QE2—shorthand for the Fed's plans to buy more Treasuries in an effort to drive down long-term interest rates. More than 60% of poll respondents say commodities will keep climbing in coming months, against just a handful who say prices will fall.
The managers are a bit more skeptical of the rally in gold. Bullion is up 31%in the past year, to around $1,340 an ounce, and hit a high of $1,381.15 last month. Jeffrey Schoenfeld, a partner at Brown Brothers Harriman, marvels at gold's "amazing run"— prices bottomed below $200 in the late 1990s—but says "mean reversion" suggests gold and other commodities eventually will underperform.
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