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Chadwick: '99 profits bright for earnings
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December 24, 1998: 12:05 p.m. ET
Strong economy and mergers spell good news for profits, analyst says
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NEW YORK (CNNfn) - A month ago, concerns about an economic and profit slowdown set into the market. Those concerns dissipated quickly with some solid outlooks in sectors such as banking and technology.
Valuations, however, are again at historic highs. Should we bother worrying? Not necessarily, says Patricia Chadwick, head of U.S. equities at Invesco, New York, who spoke with CNNfn's "Business Day" Thursday.
BEVERLY SCHUCH, CNNfn: You're actually more focused now on the future of corporate earnings.
PATRICIA CHADWICK, INVESCO NY: Yes. I think the market has discounted all of '98; it's looking into '99. I think there's a lot of concern about '99, but I think it's pretty evident that the U.S. economy is doing very well. Parts are slow, manufacturing in particular, but this economy is really driven by the consumer, and I think that part is strong. And I think we have the opportunity here for earnings to be surprisingly strong next year, relative to expectations.
SCHUCH: So don't worry about the high valuations? … Why are the earnings going to be stronger?
CHADWICK: Well, in fact, there are a couple of things. If you look at the S&P 500, which is really the benchmark that most people look at when they're talking about earnings for the market, a number of things have happened. About 8 percent of the companies in the S&P 500 have changed hands this year, mostly because of mergers and acquisitions. And the new companies that have come in are growthier than some of the companies that have gone out. Furthermore, a lot of the acquisitions that are taking place really are going to add to earnings.
An example is Tyco (TYC). They bought U.S. Surgical, which is in the S&P 500, and now they're buying AMP (AMP). Both of those acquisitions are going to meaningfully add to earnings.
So we have some really major corporate restructuring going on in this country at the same time that the economy is fine, and we've got growthier companies coming in to the S&P 500.
JOHN DEFTERIOS, CNNfn: Could that be a disappointment in a sense, because if you look at the S&P 500 it's done extremely well. That was the case this year, particularly at the NASDAQ composite, where the indices do extremely well.
Picking the stocks is going to be a bit more difficult and provide some disappointment … outside the technology sector, then?
CHADWICK: Well, there's no doubt that if you've been a big stock, you've done better than if you've been an average stock. And I would say, and I haven't done the actual numbers but I'm pretty sure that the median earnings growth for the companies in the S&P 500 has been higher, greater, than the median price appreciation. So there's no doubt that there's been a big-cap impact.
On the other hand, those big companies are doing extremely well. Look at GE (GE): they have just raised their dividend by 17 percent. They are signaling to you that 1999 is going to be a very good year. They're the biggest company in the S&P 500. If their earnings are up 14 percent, which they seem to think they can do next year, that is -- let's call that 13 percent real growth -- that's a powerful impact on the S&P 500 as a whole.
DEFTERIOS: It may seem anecdotal, but you're talking to a cab driver, for example, yesterday. He says, 'I want to get myself a computer and take advantage of this Internet craze and start trading options.' And when it gets to that level, and people are saying, 'I want to start participating in this Internet rally,' they don't know what they're buying.
CHADWICK: That is certainly speculation.
DEFTERIOS: And when does this end? I mean, does this -- does the frothiness have to come out in your view at some point?
CHADWICK: … There are sectors of the market that are frothy, and I would say the Internet sector is frothy, not to say that there aren't real winners. I mean, AOL (AOL) is now going into the S&P 500.
That is a real company. It has a bigger market cap than Disney (DIS).
Maybe some of that is going to pull back a little bit.
If the cab driver had said, 'I want to buy my computer so that I can buy things through the Web,' that would be one thing. But I think that there is no doubt that there is going to be a lot of money made and a lot of money lost buying Internet stocks. What is going to happen, though, is the amount of commerce done through the Internet is going to grow exponentially.
SCHUCH: And this is a time of year we're seeing a lot of money flowing into the markets, as we mentioned before. Is -- are we seeing the January effect early now? Do you expect this to continue then?
CHADWICK: Yes, I know, the January effect used to truly be a January effect. Then it was always taking place in December. You've got window dressing; I'm not sure what effect you should call it anymore.
But there is always a lot of churn at the end of the year. People want to show certain things in their portfolios. Maybe the air comes out of the balloon for some of the Internet stocks at the beginning of next year; that would make sense.
DEFTERIOS: In 10 seconds, if you're going to put together a model 401(k) plan, how heavy bonds, how heavy stocks for '99, at least to start.
CHADWICK: If it's a 401(k) plan and you're in your 20s and your 30s, and you're looking to taking that when you're 59-and-a-half or older, I would definitely have the preponderance in stocks. 
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