Douglas Cliggott the senior stock market strategist at JP Morgan Securities, is a born optimist.
Cliggott, 44, peppers his conversations with "Cool!" and "OK," and when he ends a call with "Great to talk to you," he sounds as if he means it. Asked what part of the work week he likes best, he replies: "Fridays are my favorite. I shouldn't say that. No, I like all the days" -- without self-consciousness.
PHOTO: NY TIMES
But Cliggott, who forecasts the equity market's direction for JP Morgan Securities, the investment banking arm of JP Morgan Chase, is anything but cheery about stocks. Since the spring of last year, he has been more pessimistic about corporate earnings and the stock market than just about any other strategist. With the average stock in the Standard & Poor's 500 down about 30 percent over that span, his worries have proved all too real.
Underestimation fear
Now, with stocks trying to rally for the third time this year, Cliggott is again warning his clients to be cautious. The market's recovery in the last month puzzles him. He believes that investors are underestimating how far corporate earnings will fall in the next few months and overestimating the speed at which they will recover.
His concerns increased on Sept. 11, though he has not tried to quantify the effect that further terrorist violence might have on the economy or on stocks -- the risk of more attacks is simply unknowable, he said. But by forcing businesses and the government to spend more money on security and defense, the attacks will probably slow economic growth and increase inflation for several years.
"The strength of the bounce in the market has certainly been a surprise for me," he said earlier in October. As earnings plunge over the next few months, the market will follow, he said.
The Standard & Poor's 500-stock index, which includes most big US stocks, could fall to 800 by next spring, Cliggott said.
His view is hardly common on Wall Street. Most strategists at other big securities firms say earnings could recover as early as the first quarter of next year and that a full-bore economic recovery will be evident by spring. The average strategist expects the S&P 500 to stand at 1,330 by the end of next year, 21 percent above Cliggott's forecast of 1,100.
But for the last two years, the consensus has been wrong. As a result, Cliggott is catching the ears of investors who once listened closely to more bullish strategists like Abby Joseph Cohen, the chief US stock strategist at Goldman, Sachs, and Jeffrey Applegate, the chief investment strategist at Lehman Brothers. At her peak, Cohen, the star strategist of the late 1990s, moved markets with a few words.
Cliggott is not nearly that influential -- at least not yet. But when Institutional Investor magazine listed its All-America Research Team on Oct. 17, based on a survey of professional money managers, Cliggott was ranked among the top strategists for the first time. He placed No. 3, behind Michael Goldstein of Sanford Bernstein and Edward Kerschner of UBS Warburg.
Cliggott was not the only bear on Wall Street during the last two years. But many of the others are dismissed by professional investors as "perma-bears," pessimists who have called stocks overvalued for a half-decade or more. Cliggott has been both bullish and bearish over that span.
"He's a great strategist," said Scott Schermerhorn, who manages US$3 billion for Liberty Funds in Boston. Some strategists make up their minds about the market's direction, then search for data to support their views, Schermerhorn said, "but Doug just looks at data and interprets what the data seems to be telling him."
That strategy served Cliggott well in January, when the Federal Reserve made the first of nine cuts in short-term interest rates. Most of his rivals predicted that the cuts would prompt a strong recovery in the economy and in corporate earnings, which began to fall in the last months of last year. But based on trends in corporate investment and commodities prices, Cliggott correctly said that earnings would remain weak and that the rally would not hold. His prediction that a late spring rally would fizzle also proved correct.
"He's been out there, in a bearish position, and he's been correct," said Jon Brorson, director of equities for Northern Trust, which manages US$100 billion in US stocks.
Cliggott says the secret to his accuracy over the last 18 months has been his focus on the direction of short-term corporate earnings. Predicting earnings more than a few months away is extremely difficult; most investors do not look more than two quarters ahead, he said. Other strategists also think corporate earnings are a vital indicator of the direction of stock prices, but they spend more time trying to determine what earnings may be in a year or two. Cliggott says that exercise is largely wasted. "Everyone wants to believe the market trades off earnings 18 months from now," he said. "It doesn't."
So while other strategists, like Cohen, look at a broad basket of indicators, Cliggott has lately focused on corporate investment in the US and commodity prices worldwide, the two statistics that JP Morgan has found are most closely correlated with short-term earnings trends.
Business quickens
Higher commodity prices are a sign that business activity is quickening, Cliggott said, while investment in computers, new plants and other equipment helps to increase productivity, driving the long-run growth of the economy.
Thanks to a quirk in accounting rules, rising business investment also gives a strong short-term boost to corporate profits. If Compaq sells new computers to Exxon Mobil, for example, Compaq can book the entire sale immediately as revenue. But because the computers are an investment that will lose value over time, Exxon Mobil can write off their cost gradually over several years.
As a result of the difference in the ways that the seller and the buyer treat the deal, periods of rising business investment are very good for corporate profits, Cliggott said.
The process works in reverse if business investment falls, as it has in recent months. Then companies like Compaq may see their sales fall, while companies such as Exxon Mobil will still be writing off investments they made in previous years.
Together, the direction of commodity prices and business investment accounts for about 65 percent of the short-term swings in corporate profits, Cliggott figures.
Unfortunately for investors, both commodity prices and business investment are still falling, and there is no sign that a turn is imminent. So Cliggott expects earnings to skid at least until the spring of next year, and to recover only moderately for the remainder of that year.
He predicts earnings in the next 12 months will sink as low as US$37 per share of the S&P 500, compared with a high of US$55 a share last year.
Of course, Cliggott could be wrong for any number of reasons. Interest rates could fall, enabling stocks to trade at higher price-to-earnings ratios. The market could move sideways while investors wait to see how next year unfolds -- or earnings could recover quickly.
Cliggott says he is aware of all those possibilities. But for now, he says, stocks are so overvalued that he is not worried that he will miss a big rally. "It's far more likely that the market could be down 20 or 25 percent than up 20 or 25 percent."
Risks raised
And that, Cliggott said, does not factor in the risk of more terrorist attacks, though Sept. 11 has raised risk for the economy and stocks.
Those risks include too much government interference in the economy, he said. He grew up in a Boston suburb and is a Democrat -- he jokes that anyone from Massachusetts is born a Democrat and a Red Sox fan -- but like most people on Wall Street, he thinks the federal government should usually stay out of the way of private business: "The risk is that government starts taking on a bigger role in America, or a bigger share of the economy, rather than a smaller share."
Spending on security and the military may cause inflation to rise, Cliggott said. Businesses buy computers, or add to their sales forces, because they think the spending will increase their revenue or profits. But improving security is a strictly defensive measure that forces businesses to spend more to produce the same product or service they previously did. That is inflationary, and higher inflation is typically a drag on stock prices, he said.
To make sure that he does not repeat what other strategists say, he does not read his competitors' reports. He said he figures that if another strategist unearths an important new statistic or trend, his clients will tell him. In a typical week, Cliggott will lead a dozen or more hour-long conference calls or presentations with big investors, and spend much of the remainder of his time responding to questions from other clients. His list of business contacts is almost 300 names long.
With his outlook, he is again advancing an opinion that is well outside the Wall Street consensus. If the market holds its recent gains or rallies further, his view will be proved very publicly wrong.
Cliggott says that standing alone does not bother him. "I got hugged a lot as a kid," he said, only half-joking. If his indicators show that earnings are turning higher, he said, he will not be afraid to turn more bullish. Otherwise, he does not plan to change his outlook.
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