How Much Higher?

For the market, 1997 had peaks and valleys. What's to come this year?

market, while simultaneously increasing the worth of bonds with hither yields. Our panel’s fixed-income expert, Mark Lay, thinks rates will fall in the first half of the year, but could come under pressure later in 1998.

I see a very positive year ahead for both the stock and bond markets. Interest rates will probably go down in the first part of the year and perhaps rise a little later on. We also don’t expect Alan Greenspan’s Federal Reserve to raise rates this year.

In 1997, the U.S. economy enjoyed strong growth and a rise in employment. Those are factors that might overheat the economy and worry the Fed about inflation. Nevertheless, inflation remained low at 1.7% for the year–the best number since 1965.

A number of things will keep a lid on prices. For instance, the U.S. dollar has been strong in relation to European and Asian currencies. That means our goods are more expensive overseas, but it also means a rise in cheap imports, which in turn keeps prices down. Commodity prices have also behaved well. Look at oil: early in 1997, it was as high as $20 a barrel. Now it’s under $17.

There are indications that the bond market feels the turmoil in Asia will slow the economy and the Fed will cut rates to keep things going strong. I don’t think the Fed will do anything when inflation is this low. So bond yields on the 30-year Treasury, which as we speak are at 5.73%, could go down. We could touch 5.50%. But I believe as the second half of the year rolls around, we’ll see signs of stronger economic growth, which should push rates up. At the same time, if you look at the fact that unemployment is at a low, which could push wages up, there’s no way the Fed is going to lower rates.

As Lay pointed out, the bond market won’t interfere with rising stock prices. But with the exception of Lay, our panel thinks stocks will have trouble matching the kind of gains made in last year’s market.

Based on the current economic factors, I see no need for a major correction in equities. We’re very positive for 1998. In fact, I wouldn’t be surprised to see another 20-plus year. A lot of people are saying, ‘We were up 30% last year, there’s no way we could repeat,’ but there are a number of positives they tend to overlook: low inflation and consumer confidence being at all-time highs.”

To my thinking, corporate profits could rise between 5% and 8% this year. Right now, though, I think one thing to worry about is the fact that the market is at an almost excessively high valuation. The S&P 500 is selling at a price-to-earnings ratio (P/E) of about 20 times 1998 earnings levels- among the highest ever. Since we’re at the high end, there’s a good chance the market will undergo a correction. That’s a good thing, because once we get

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