Gaming the 2004 Consensus

Market valuation is one place to seek shelter. With names such as Yahoo! and eBay trading at a triple-digit trailing P/Es, it is hard to become excited about Internet names from a valuation standpoint. In the stock-friendly scenario being proffered by most brokerage firms, it could very well be that 2004 is a year for value-oriented stocks–those with real earnings that trade at or near book value–than for more speculative issues. That was the case in 1992, which was the last presidential election year that followed an economic recovery and is believed by many to be a good proxy for what lies ahead in 2004.

The issue of capitalization is a bit more muddled. With small caps dominating investment returns in 2003, it seems unlikely that they can put in a repeat performance next year. However, that was the result in 1992, which saw the Russell 2000 Value index appreciate by about 18% while the overall market was up less than 10%.

The outlook for bonds is not nearly as friendly. Nearly every Wall Street firm is turning their backs on the Treasury market, with the common logic that 4% GDP growth is not conducive to historically low short-term rates. But for those who aren't expecting a continuation of the massive rally in the corporate credit market, Treasuries may indeed be a good contrarian hedge.

With credit spreads already at low levels, it seems hard to imagine that spuriously priced junk bonds can rise much further than the nearly 30% gain they enjoyed in 2004. Further, a steadily swelling deal calendar has resulted in issues that lack both quality and, in some cases, common sense. The same can be said for the convertible bond market, even though the sector suffered through an appreciable selloff in the summer.