After another sizzler in '96, the market may cool off

THE BALTIMORE SUN

The experts' outlook for mutual funds in 1997 is pretty much the same as they issued for 1996, and investors should hope they are as wrong now as they were then.

But don't bet on it. Two years of huge gains in the stock market have rarely been followed by a third.

A correction followed by a recovery is not unexpected.

Last year, coming off a sizzling 1995, when the Standard & Poor's 500 index was up more than 37 percent, economists and fund managers lowered expectations, suggesting that 1996 would be a slow growth year, with funds up 7 percent to 10 percent.

Instead, despite the greatly increased volatility in the market and the year-end gyrations, it was another excellent year. In fact, the 1995-1996 period was the best two-year performance since 1954-1955, based on the S&P; 500.

But on the theory that all good things must pass, or at least revert to the norm, the experts are once more predicting a more moderate year, with gains in the 7 percent to 10 percent range. At least those who aren't predicting an outright recession.

Some are even predicting a correction -- a market decline of 10 percent or more -- but with the averages still increasing for the whole year.

"I think it is almost impossible to predict that equity funds will perform as well as they did this year and last year," said Porter Morgan, investment strategist for Liberty Financial in Boston, which owns the Colonial and Stein Roe mutual funds.

"I think if the market is up 7 to 12 percent next year, most investors will be very satisfied, coming off the kinds of years we have had," Morgan said.

Arnold Kaufman, editor of Standard & Poor's Outlook investment advisory, said: "I think the S&P; 500 index will be about 770 at the end of 1997, about a 7 percent gain from where it is now." The S&P; 500 index started 1996 at 616, so the gain for the year is about 17 percent.

Overall, the consensus seems to look like this: continued slow economic growth, with lower corporate earnings, no inflationary pressure and long-term interest rates in the 6 percent to 7 percent trading range. The Federal Reserve Board will either minimally increase or even slightly decrease interest rates if necessary to spur the economy.

"I think next year will be slower than this year," said Robert Froelich, chief investment officer of Van Kampen American Capital in Oak Park, Ill.

"There will be slower earnings growth," Froelich said. "Then I think the Fed may cut rates and that will lead to a good pickup in the second half of the year."

Van Kampen was bought by Morgan Stanley this year, and its chief global strategist, Barton Biggs, sees a totally different picture. Biggs, who has been bearish for a while, is predicting a recession next year.

S&P;'s Kaufman said he sees a recession coming also, but not next year.

"A 10 percent correction next year would not be a lot to expect after the 50- to 60-percent gains we have seen, but I think a 1998 is far more likely to see a recession," he said.

A correction is considered past due. Robert Doll, director of equity investments at Oppenheimer Funds in New York, said the stock market has gone without a 10 percent correction for almost seven years, but historically the market corrects by that amount every 30 months, on average. "A correction is not only overdue, but it's the small step back we need to take another long stride forward," he said.

Part of the fuel for last year's market explosion was the pressure of huge amounts of new cash into mutual funds at the beginning of the year: about $125 billion in the first five months, and probably more than $200 billion for the full year when the final numbers are tallied.

"I would guess that it is not likely that kind of pace will continue," said John Rea, chief economist for the Investment Company Institute, the mutual fund industry's trade group.

"The pace slowed down in the second half, but it is still a pretty good foundation for next year, but not like it was coming off 1995," Rea said.

S&P;'s Kaufman doesn't think the inflows will continue at the 1996 pace, but that they will continue strongly.

"There is a compelling demographic argument for stock ownership with the baby boomers," he said.

"And I think the well-off elderly will continue to buy stock and certainly not sell. The problem is the hot money from hedge funds and foreign investors might be pulling out for better opportunities elsewhere, which is what is probably setting off the market right now. But new money will keep coming in from the 401(k) plans."

If all that isn't convincing, Kaufman says, there are some "statistical oddities" that point to a flat 1997.

"The year after a presidential election usually averages about 2.5 percent. And years ending in a seven have not been good, with declines averaging about 7 percent," he said, adding, "I wish I hadn't laughed when everybody said years ending in fives are good."

Pub Date: 1/05/97

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