WSJ 9/2/03
VACATION'S OVER. Now what?
Thomas McManus, who forecasts the stock market for Banc of America Securities, is feeling upbeat going into the last stretch of the year. He says stocks could rise another 5% or 10% before the year ends, to their highest levels in more than a year.
But Richard Bernstein of Merrill Lynch sees a chilly autumn, saying stocks are so overpriced that they could fall as much as 14% during the next year.
Such sharp disagreement between two such experienced analysts, both of whom rightly saw stocks as overpriced during the bubble, is the sort of thing that is making some experienced money managers particularly nervous right now.
That, and the fact that the stock market is entering its nastiest season.
September is when stocks have done their worst during the past century, posting declines on average. October is a month when stocks sometimes have crashed. But October also is a month when the market sometimes has taken off, as investors shook off worries and looked ahead to what analysts sometimes call a "Santa Claus rally."
No wonder some pros are feeling uncomfortable as they return from the beach.
The stock market is starting to feel like "the mania-inspired trading environment of the late 1990s," a time in which investors ignored repeated warning signs, says investment strategist John Caldwell at McDonald Financial Group in Cleveland, a brokerage and money-management arm of KeyCorp.
"Rising interest rates? No problem. Overly aggressive earnings forecasts? No problem. More violence in Iraq? No problem," he remarked last week in a report to clients.
The gains of the past 10 months have been dizzying -- including a late-summer rally for Nasdaq stocks in particular. As the August trading month ended on Friday, red-hot technology stocks had driven the Nasdaq Composite Index up 63% from the low that the index hit in October of last year. It is up 36% this year alone, at a 16-month high.
The Dow Jones Industrial Average recorded its sixth straight month of gains in August, including a 0.7% rise last week, with an advance of 41.61 points, or 0.44%, to 9415.82 on Friday. (The market was closed yesterday, Labor Day.) It has risen 13% so far this year, while the broad Standard & Poor's 500-stock index is up 15% on the year. The industrials now are just 13.08 points short of their 14-month high of 9428.90, while the S&P is 3.63 points short of its own 14-month high of 1011.66.
The Dow Jones industrials have been down for the past three years, but they haven't registered four consecutive down years since 1932. Now, after the stock market's strongest rally since the Internet bubble burst in March 2000, hopes are spreading that the major indexes could turn in their first year of gains since 1999.
The worry is that investors have overdone things again.
The S&P 500 sells for more than 18 times its companies' forecast earnings for the coming 12 months, and the Nasdaq composite for nearly 40 times its corporations' forecast earnings, according to market-research firm Birinyi Associates. Neither is back to its high of the bubble. But what worries the skeptics is that stock prices never fell to below-average levels, compared with earnings. During a normal cycle, they should do that.
Market timers, who try to forecast short-term market moves, have begun warning that the current rally is getting old and that the market is overdue for at least a temporary pullback.
The Nasdaq composite "has already jumped over 61% while profits are up just 7% to 15%," notes Ned Davis of market-research firm Ned Davis Research in Venice, Fla. "Much of the good news is already in prices, and we could see a short-term market correction in September."
Stock mutual funds in July registered their strongest inflows in more than a year, he adds, but money managers put all of that and more into stocks, dipping into cash reserves. That leaves them relatively little extra money to invest now.
Some short-term analysts are forecasting a give-back of one-third to one-half of the gains registered since March. But even some skeptics, such as Mr. Davis, think the market still shows signs of life.
Optimists think there is no problem at all. Stocks should be trading at higher price-earnings ratios than normal, they say, because interest rates fell this year to 40-year lows. When interest rates are low, profits can grow faster than usual -- as evidenced by recent economic reports.
What's more, alternative investments such as bonds are less appealing because their yields got so low. Even with the sharp rebound of the past two months, the 10-year Treasury note still yields only 4.466%, which hasn't been pulling much money out of stocks.
" `Tech' may still be a four-letter word for many investors," wrote Smith Barney economist Steven Wieting in a recent report. But the Nasdaq composite still is only back to one-third the record level of 5048.62 hit early in 2000. "We can't avoid the conclusion that the information-technology sector will likely provide the strongest rate of earnings recovery in the S&P 500."
David Briggs, head of stock trading at Pittsburgh mutual-fund group Federated Investors, was a skeptic until spring. He has been impressed with the market's resilience, and thinks the rally will continue. "We have cash coming into stock funds," Mr. Briggs says.
Why? Earnings are up, and are expected to continue to improve for the next two quarters. "The economic news has been better," he says. "It isn't a roaring bull market, but it is sort of steady-Eddy improvement that should permit the market to keep moving ahead from here."
Mr. Briggs expects a gain of 8% to 10% for the S&P 500 before year end, although he says it is too soon to know whether the fundamentals will be strong enough to sustain it very far into the new year.
Some analysts worry that a strengthening dollar and rising market interest rates (in the form of higher bond yields) could cool off the rally. Mr. Bernstein of Merrill Lynch recently forecast that, based on the performance of recent economic indicators, earnings growth may be getting ready to top out.
Moreover, investment bankers are planning to take advantage of the strong stock market to launch some new stock issues this month. On a simple supply-and-demand basis, new supply could weigh on stock gains.
Given the mix of positives and negatives, many investors and analysts are concluding that any stock gains now will be much less robust than they were during the summer.
"The quality of earnings I think is very strong and continuing. A dollar of earnings is really meaningful money, rather than just accounting changes," says Keith Karlawish, president of BB&T Asset Management, the money-management arm of BB&T Corp., a big regional bank based in Raleigh, N.C.
But, he adds, "a lot of earnings have been around currencies and cost-cutting. You wonder how much more of that there will be going forward." Mr. Karlawish thinks the market can put in mild gains, but "you have to see the validation of that in the [earnings and economic] numbers as they come through."
Even the bullish Mr. McManus of Banc of America warns that the sharp gains are "now behind us." With stocks closer to fair value, they are likely to rise in line with the pace of earnings gains -- at 7% to 9% a year, he says.
Market strategist Brian Belski, at Minneapolis brokerage firm U.S. Bancorp Piper Jaffray, says the S&P 500 could finish the year roughly where it is right now, after some ups and downs.
Next year, "I think it will be up, but once again it will be rather tepid," Mr. Belski says. He, too, forecasts single-digit annual growth unless corporate profitability jumps.
One thing that could support stocks: "Clients are getting more optimistic again," Mr. Belski says. "A year ago, I was getting emotionally-laden questions: `When is this thing going up again? When am I going to make money again?' Now, it is: `What do you think of this sector or this stock?' "
With Merrill Lynch & Co. looking bloated in the wake of the long bull market of the 1990s, its board tapped Stan O'Neal to be its next leader and make hard choices about the firm's direction.
He's doing much more than cutting costs. He is completely reengineering the famous 88-year-old securities firm.
The Merrill of old was a financial supermarket, seeking to compete in all areas of the securities business. The firm muscled its way into most of the biggest stock and bond underwritings, partly because it had a vast force of 20,000 brokers to sell the securities. It had a deep bench of senior people who spent much of their time calling on clients and a growing international empire.
Mr. O'Neal has scaled back that ambitious mission. His Merrill doesn't seek to be all things to all clients. Slashing staff, recently launched ventures and low-margin operations, he is urging managers to move nimbly in and out of whatever areas offer the best returns at a given time.
His strategy is a bold gamble. If it works, the franchise could vault to a new level of prosperity. The second quarter was the first piece of evidence, Mr. O'Neal has said. Merrill earned a near-record $1.02 billion, thanks to cost cuts and a good climate for bond trading. Merrill's own shares are up 70% since March.
But the strategy also is fraught with risks. Merrill's business depends on relationships. Mr. O'Neal has so streamlined the ranks that some clients now don't have long-running ties with the bankers and brokers trying to get their business. In other cases, Merrill has drastically scaled back services that clients depended on. His is a delicate business challenge: As a CEO out to radically reshape a famous company, Mr. O'Neal must create the new model without losing the culture and esprit de corps that made the company special and its clients loyal.
So far, his campaign has been messy. Since he first rose to a position of power two years ago, Merrill's work force has shrunk by one-third -- 23,000 jobs. With no trace of nostalgia, the 51-year-old Mr. O'Neal has rid Merrill of an entire bench of senior leaders. Eighteen of the 23 members of the executive management committee in the previous administration are gone, many forced out as Mr. O'Neal has consolidated his power.
A month ago, he even ousted Thomas Patrick, a veteran banker who had helped engineer Mr. O'Neal's own rise to the top spot. Mr. Patrick incurred the boss's displeasure by working to install a protege as Merrill president. Soon that protege, global-markets and investment-banking chief Arshad Zakaria, 41, was also asked to resign, say people familiar with the decision. Merrill described both departures as retirements. Mr. Patrick declined to comment. Mr. Zakaria has previously declined to comment through a firm spokesman and didn't return a call to his home yesterday. When Mr. Zakaria leaves at year end, only three of eight high-level executives Mr. O'Neal initially promoted will remain at the firm.
Mr. O'Neal declined to be interviewed. Paul Critchlow, counselor to the chairman and vice chairman of public markets, says of the executive departures: "Part of our culture has been to protect people who are past their performance prime because they're nice people and they've served the company for a long time. But it's a perversion of the principle `respect for the individual' if, in protecting someone like that, you're hurting thousands of other employees who might work for that individual."
The Merrill Mr. O'Neal inherited was earning $1.7 billion less than rival Morgan Stanley on almost exactly the same revenue, about $45 billion. Those were the figures for 2000, the year before the Merrill board picked Mr. O'Neal as president and heir to Chairman and Chief Executive David Komansky. By late 2001, Mr. O'Neal was largely running the show, although he didn't become CEO until late 2002. He added the chairman's title earlier this year.
Most of his predecessors had been gregarious former stockbrokers who favored broad expansion as the way to profits. They sought out the biggest investment-banking deals, built up the asset-management business through acquisitions and aggressively opened overseas offices. Meanwhile, Merrill pursued not-so-profitable businesses such as commercial paper -- issuing short-term notes for clients -- partly as a way to gain face time with corporate-finance officials.
Mr. O'Neal refocused Merrill sharply on high-fee areas, such as complex debt financings, as well as on trading for its own account, foreign exchange and derivatives. In place of older bankers who stressed relationships, in came a brigade of forty-somethings with a quantitative focus. Mr. O'Neal slashed several thousand jobs outside the U.S. That pullback stanched hundreds of millions of dollars of losses the firm was incurring in Japan. The new strategy and cost savings helped yield much-improved profit margins for Merrill in the 2003 second quarter, and more gains may be in store.
But like the dismissals, the business cutbacks have sometimes been sudden and left a bad taste. An example involves "private equity" deals, in which investment firms pool their own and investors' money to buy stakes in companies. The idea is to sell them or take them public later for a big score.
From mid-2001 to March 2002, a group of Merrill bankers pushed hard to obtain $500 million in commitments from clients to invest in health-care companies. Several institutional investors did months of due diligence and finally committed money. One was Pennsylvania Public School Employees' Retirement System, which pledged $225 million. Merrill brokers also solicited money from individuals and pledged $300 million of the firm's own cash.
Just as the private-equity fund was to launch last summer, Merrill cancelled it, telling its bankers the long-term investments didn't fit with its need for quick results. The move embarrassed bankers and dismayed clients. "We were moving ahead, everything was proceeding fine, and it was Merrill Lynch that kind of abruptly pulled the plug," says Evelyn Tatkovski, spokeswoman for the Pennsylvania teachers' fund.
Most of the Merrill bankers who were slated to run the canceled venture have left and relaunched it elsewhere, but the Pennsylvania fund didn't invest in the new fund. Merrill declines to explain why it axed the private-equity venture. Mr. Critchlow says, "Nobody lost any money because nobody was invested."
Speaking generally, he adds that "Stan moves very quickly. He does not allow things to fester. Sometimes you have to move forward and it's not always neat and clean and perfect."
Another area Mr. O'Neal pared back was the investment bank, the group that underwrites stock and bond offerings and advises on mergers. Earlier Merrill leaders pushed to get into as many deals as possible, as a result winning top spots in what Wall Street calls the "league tables." But Mr. O'Neal and his since-ousted deputy, Mr. Patrick, diagnosed two problems. Too often, the firm was chasing high-profile deals that didn't earn it high returns. And Merrill was using too much of its capital to support underwriting transactions.
An early target was junk-bond underwriting. This had once been a big force at the firm, and Mr. O'Neal began his Merrill career in the group in 1986. The Alabama native, grandson of a man born into slavery, had earned a Harvard M.B.A. and was working in finance at General Motors Corp. when he was recruited to join Merrill's investment bank. By 1998, Mr. O'Neal was chief financial officer and winning plaudits for ensuring the firm's liquidity during the Long Term Capital Management hedge-fund crisis.
Later, as brokerage chief, Mr. O'Neal gave a foretaste of his CEO reign. He replaced virtually all of the senior leaders of the group, began sharply trimming staff and sought more-profitable business. Mr. O'Neal redirected brokers away from serving the "little guy," decreeing that brokers no longer could earn trading commissions on accounts of under $100,000. It was a radical move for a firm that once boasted it brought "Wall Street to Main Street."
Mr. O'Neal grew close to a fellow cost-cutter, Mr. Patrick, who as chief financial officer helped persuade Merrill's board to designate Mr. O'Neal president and heir apparent in 2001.
When Messrs. O'Neal and Patrick analyzed the junk-bond-underwriting operation, they decided it was too risky and required too much capital, say people involved in the operation. Merrill soon laid off several dozen bankers in the group, which one banker estimates had numbered about 70. Some others quit. Merrill, citing competitive reasons, declines to say how big the group had been or how many people remain in it.
The cutback may mean less risk for Merrill. But the downside is that when buyout firms do giant leveraged deals, they often rely on junk bonds and tend to award their business to banks that can cater to all their needs. The loss of its junk-bond clout hurts Merrill's ability to get some big deals, say investors at some buyout firms.
Before the cutback, Merrill earned millions of dollars by handling a 2001 buyout of Britain's yellow-pages business. But when a similar deal loomed last year -- Qwest Communications International Inc.'s sale of its U.S. directory business to two buyout firms -- those firms didn't ask Merrill to handle the financing. Merrill's only role was to produce a fairness opinion for Qwest, a less-lucrative job.
Merrill declined to comment on strategic moves such as the junk-bond cutback or whether it affects the firm's ability to win buyout-firm clients. The firm portrays any client business that Merrill may have lost since Mr. O'Neal took over as an expected consequence of refocusing the firm and trying to provide more-valuable service to clients.
Merrill still has prodigious capabilities in investment banking. Its ups and downs with one buyout firm, Leonard Green & Partners, illustrate that capacity but also the central role that relationships play in the business.
One of the Merrill bankers who called on the Green partners was someone they knew from his previous employment. In 2002, when Green and a partner, Texas Pacific Group, took public a pet-supply company they owned, they made Merrill a co-leader of the initial public offering. Merrill earned an estimated $4 million in fees on the Petco Animal Supplies Inc. IPO.
Merrill bankers who handled leveraged-buyout clients were pumped up. They were landing roles in some of the year's biggest buyout deals. One of the bankers handed out T-shirts that showed a big green target and read "elephant hunting."
But last fall and this spring, Merrill laid off some of those bankers, including the one with whom the Green partners had a history and a senior banker who called on retailers such as Petco. Merrill also dismissed its main research analyst covering Petco. Soon, Merrill watched from the sidelines as Green and Texas Pacific gave a second Petco stock deal to two Merrill rivals, Morgan Stanley and Goldman Sachs Group. Merrill also was left out when Green facilitated a merger involving another business it owned, Gart Sports Co.
"We don't idly change lineups," says John Danhakl, from the Leonard Green firm. But losing so many Merrill contacts created a "headache," he says, leading the partners to conclude "we should have somebody else leading the [Petco] deal." Merrill declined to comment.
Merrill's current bankers have been working to rebuild client relationships. The Green firm gives them high marks for coming back and "taking a personal interest in us," as Mr. Danhakl says. The buyout firm is also pleased that Merrill has resumed analyst coverage of Petco and says it would use Merrill again.
The effort to build relationships includes Mr. O'Neal. His is not the schmoozing style of some bankers. "Stan gets in there. He understands their business. He offers ideas and solutions," a Merrill spokesman says. In characteristic numbers-crunching fashion, Mr. O'Neal says through the spokesman that he held 112 client meetings in the first quarter of the year and 119 in the second quarter, and he expects 200 more for the second half.
In an indication of improving relationships, Merrill bankers in Europe recently handled a multibillion-dollar public offering of Yell Group PLC, the British yellow-pages publisher that Merrill had earlier helped buyout firms to take private. Merrill also played a prominent role in General Motors Corp.'s giant $17.6 billion financing in June. And it scored a coup with Qwest by helping the telecom company with a complex $1.75 billion loan, earning an estimated $10 million fee. Merrill says it also has started rebuilding the junk-bond group.
Merrill expects its retooled brokerage unit to help fuel growth. Now down to 13,300 people from a peak of 20,200, the brokerage force is putting added emphasis on such efforts as mortgage and small-business lending. Still, last quarter, Merrill saw a net $1 billion in brokerage clients' assets walk out the door, while Citigroup's Smith Barney unit was attracting $9 billion. Merrill attributes part of the drop to the loss of a large 401(k) retirement plan it had managed.
All the changes at Merrill, particularly the widespread high-level dismissals, have subjected the new regime to sharp scrutiny. Analyst David Hendler of CreditSights Inc. says "the management progression is more seat of the pants than it is long-term strategic planning." Former Securities and Exchange Commission Chairman Arthur Levitt, who years ago called the firm "one of the few on the Street with a soul," now says of Merrill, "A firm that operates in an environment of fear is a firm where it is very difficult to establish the kind of bonds that come from trust and loyalty." At the same time, one Merrill insider proudly likens those who've survived the tumultous period to elite "Marines."
Mr. O'Neal recently acknowledged the harsh image his effort to remake Merrill has given him. At a Florida asset-management conference in May, he said news coverage made him sound like "some kind of Quasimodo, prowling around the dungeons of Merrill Lynch, torturing costs out of the system." Lately, he has made an effort not just to change Merrill but to reconnect with its past.
Last month, he recruited back to Merrill a popular veteran, Robert McCann, who had left in frustration this year. Faced with questions about the many recent departures at the firm, Mr. O'Neal told employees in a broadcast Aug. 12 that he is now stressing the need "to think about things with a true partnership mentality."
WHILE MANY Americans feel insecure about their jobs in the current tough labor market, workers in certain fields enjoy a surprising degree of job security.
These careers often have industry-specific reasons for their strength, but typically they have three things in common: Many require considerable training and certification even though pay levels can lag behind those in other careers. None of these jobs can be outsourced to lower-cost nations. And the most secure jobs are often seen as undesirable to many job seekers.
Among these are many positions in health care, which often is stressful and can have higher injury rates than some construction jobs. Another field, selling cars, takes relentless effort and garners little respect.
Then there are funeral directors. Healthy demand for their services hasn't erased the stigma associated with the job. As a result, the Robert A. Pumphrey Funeral Home in Bethesda, Md., boosted starting pay to between $35,000 and $40,000, compared with the industry average of $25,000, and now offers to buy suits and cellphones to lure students still in mortuary school. "It's the market reality," says John Chaplin, Pumphrey's vice president.
Veterinarians are another field were demand can outstrip supply. Loyal Fido owners shelled out 40% more on pets in 2001 than they did in 1996, despite a lousy economy, which has translated into job security for vets and rising pay: Their average salary in 2001 was $84,000, up 15% from 1999.
Many working Americans aren't so lucky. More than nine million people, from computer programmers to factory workers, are looking for work. Millions more say they don't make as much money at they should.
Here's a look at three careers that are thriving:
Mortuary Services
Patty Hutcheson, president of Gupton-Jones College of Funeral Service in Decatur, Ga., visits local high schools touting work as a funeral director. "Usually, I get, `Ewww, why would anybody want to do that?'" she says.
Indeed, it can be a tough sale. Embalmers and funeral directors handle corpses and grieving families daily. They are on call to pick up the deceased at all hours of the day. On top of that, those starting out typically make between $20,000 to $25,000 a year. "This is a field where people get into it not for the money but for a sincere desire to help people in time of need," says Martha Gaidies, department chairwoman for the mortuary science department at Arapahoe Community College in Littleton, Colo.
Consequently, new enrollment in mortuary-science programs plunged 30% to about 2,200 students between 1996 and 2001, according to the American Board of Funeral Service Education, a Portland, Maine, accreditation group. Yet as demand has risen, so has pay. Income for experienced funeral directors' rose 21% to $48,400 between 1998 and 2001, while pay for an experienced embalmer rose 13% to $34,730.
Last year, 59 funeral directors and others won an average 4% pay raise each year for six years from a group representing Chicago-area funeral homes. "It's only going to get better in the next contract because of the shortage," says Mark A. Rizzo, an Elmhurst, Ill., funeral director.
In addition to decent pay, Mr. Rizzo, 42 years old, says his job carries great rewards and challenges, the greatest being the current trend to replace the traditional somber, black-clad funeral with a celebration of life. "I would really like to put the `fun' back in `funeral,' and I mean that in a respectful way. When people step forward and share their memories, that's what it's all about," he says.
Cosmetology
Regis Corp., owner of the hair chains Supercuts and Regis Salons, estimates there are about two million licensed cosmetologists in the U.S. But only 1.1 million are in the labor force at a given time, mainly because many women leave the field to have children and never return.
Regis says it needs an additional 150 cosmetologists to staff its 72 stores in the northern Pacific region alone, while cosmetology schools say they have few problems finding jobs for graduates.
Yet even while beauty schools swell with unemployed workers looking for a new career, creating new hairdressers isn't as easy as filling the classroom. States require hairdressers to go to specialized schools and get licensed, which can be expensive and time-consuming. At Central Beauty School in Eagan, Minn., for instance, tuition is $8,700 for a 10-month program that requires students to perform 300 shampoos, 60 permanents, 75 haircuts and 50 hair colorations.
Cosmetology pay varies depending on the quality of the salon and the area of the country. The Vancouver School of Beauty in Vancouver, Wash., says starting wages for mainstream chain-store jobs have risen to roughly $9 an hour from $7 during the past two years. Of course, more upscale salons and spas pay more, and tips can boost income further.
Heather Dunn, who worked in a gift shop for about $7 an hour while attending cosmetology school, was nervous about leaving that job last spring, but immediately found a job as a nail technician in St. Augustine, Fla., where she makes three times that much.
Nursing
Nursing has dwindled in popularity since the 1990s, as other jobs offered higher pay and glitzier environs. With few people entering the field, the average age of nurses rose to 45.2 years and hospitals began scrambling to hire and retain more nurses. About 13% of positions for registered nurses were vacant on average in 2001.
The shortage has led to higher pay and better working conditions. A contract negotiated last year gives 1,000 nurses at Robert Wood Johnson University Hospital in New Brunswick, N.J., an average pay raise of 24% over three years. In July, 3,500 nurses at the northern California hospitals of Catholic Healthcare West won a 14% pay increase over two years and a ban on mandatory overtime.
Barbara Williams, a 58-year-old clinical nurse specialist at Dominican Hospital in Santa Cruz, Calif., watched younger nurse colleagues depart in the 1990s. The fast pace of the work and rising number of patients assigned to each nurse led to burnouts and career switches. Pay was another issue. In 1998, nurses, who attend college for two to four years, made an average annual salary of $43,070, not competitive in many regions with jobs requiring a similar level of education. "If they were young and able to, they walked out," Ms. Williams says. The result: The Labor Department projects nursing will be one of the top generators of new jobs during the coming decade.