The Investment U E-Letter: Issue # 310
Thursday, February 6, 2004

Stock Market Outlook: The Bear Hiding Behind Merrill’s Bull
By Dr. Steve Sjuggerud, President, Investment U

“Well, Mr. Jones, our highly paid strategist is the most bearish guy on Wall Street fortunately everything you own is rated as a buy by our analysts”

One thing’s for certain, Merrill Lynch will be able to claim at the end of 2004 that it called the stock market right. That’s because Merrill is sending out equal and opposite messages about its stock market outlook this year.

The head honchos at Merrill should be embarrassed about this. Because, based on this, Merrill’s brokers and customers now have no idea what to do with their money. That is just a disgrace. Let me explain.

When the Math and the Message Collide and Its Stock Market Outlook Becomes Confused

First of all, 93% of the stocks on the radar of Merrill Lynch analysts were rated either “buy” or “hold” at the beginning of this year. Only 7% of stocks studied by Merrill analysts were rated “sell.”

With so few sell ratings, you’d think that Merrill Lynch is resoundingly bullish in 2004. Not so fastMost investment and stock strategists are optimistic in their market outlook, but not Merrill’s.

Merrill Lynch’s chief stock market strategist is the most bearish strategist on Wall Street, judging from the portfolio recommendations of the 13 biggest-name strategists in a recent Bloomberg poll. The poll results were revealing

First, Wall Street strategists as a group are extremely bullish The median recommended asset allocation coming out of Wall Street right now is:

• 70% stocks
• 20% bonds
• 10% cash

Wow that’s nearly three quarters of your money in stocks. (I find that a bit funny, when you consider the strategist’s median estimate for the stock market (the S&P 500) is 1200. Since we’re currently at roughly 1125, that doesn’t offer up much profit potential from here. But there is a lot of risk in stocks now, and that risk is reflected in my own stock market outlook. But that’s another story. Getting back on track)

Abby Joseph Cohen of Goldman Sachs is typical of the list of strategists she recommends 75% in stocks, 20% in bonds, 2% in cash, and 3% in commodities. (Hey, at least she recommends some exposure to commodities)

Even though Abby is optimistic about the stock market, her company (Goldman) still has a relatively balanced list of stock recommendations. Only 26% of Goldman’s recommended stocks are listed as “buys,” while 20% are listed as sells. (The rest are listed as “holds.”)

When you compare the picture at Goldman to the picture at Merrill, it’s really hard to make any sense of Merrill at all Only 7% of stocks on its outlook and recommended list are sells. Yet strategist Richard Bernstein is so bearish that he actually recommends investors have less than half of their portfolios in stocks. What’s going on?

The Hidden Bear Behind Merrill’s Bull

First, you’ve got to understand that a Merrill Lynch broker is constrained in a lot of different ways in what he is allowed to say to his clients. However, if Merrill Lynch has a “buy” rating on a stock, that broker has few constraints when it comes to talking about that stock.

So the Merrill brokers want the firm to have more “buy” ratings, so they can have more stocks that they can talk about. And therefore there is a push to have lots of “buy”-rated stocks. After all, Mom and Pop America don’t want bonds or cash from their Merrill broker and chances are, the Merrill broker doesn’t know anything about commodities yet (that’s okay, his customers aren’t asking for anything in commodities yet, either).

On the flip side, Merrill’s strategist is bearish. Long story short, no matter how their stock outlook reads and no matter what happens in the market Merrill can correctly claim that it called the market right in 2004-either the strategist or the analysts got it right. Here’s what I’m getting at

The Perception and the Reality of its Market Outlook and Message

Ultimately, it’s Merrill’s responsibility to deliver a clear message to its customers about stock market investments. Merrill should be embarrassed about this disconnect between a posturing, bearish outlook and only a tiny handful of “sell”-rated stocks.

Either the firm needs a recommended list with more balanced buy and sell recommendations, or the chief strategist should be fired. My vote would be for the first choice. Either way, someone at the top needs to ask, “How could we have possibly gotten to this point?”

The higher-ups at Merrill worry about staying in compliance and brokers not screwing up. Meanwhile, their customers don’t have a clue what to do about their stocks.

“Well, Mr. Jones, our strategist is bearish fortunately everything you own is rated as a buy”

Well, unfortunately for Merrill’s customers, that just doesn’t add up.

Today’s IU Cribsheet

• A lot of what I talked about today relates to the ratio of various investments in your portfolio. Collectively, this balance is known as “asset allocation.” Smart asset allocation can make the difference between years of frustration (and lost profits) and years of continued market-beating returns on your investments. One good place to learn about asset allocation is E-Letter #270 - The Gone Fishin’ Portfolio. Another is online at http://biz.yahoo.com/edu/bi/ir_bi7.ir.html.

Good investing,

Steve

P.S. The article below is an interview with Dan Denning of Stratetic Investment featuring his own stock market outlook and predictions:

Stock Market Predictions for 2004-2005: The Best Stock for the Next 10 Years

P.S. I just wanted to follow up on my last E-Letter, where I told of how the rear window of our car was shot out while driving on Sunday. My wife and I sincerely want to thank you for your message board posts. We read them all. The young BB-gun shooter and his family came over to apologize the other night, and we even gave out copies of your responses to them. It is an upstanding local family, and they are in disbelief. Still, thanks to your encouragement, we are following it up with the State Attorney. The kid is not getting off. His actions will have consequences, no doubt. I’ll keep you posted on what happens Thank you all again.